Facebook: How the Best Action Was Inaction

June 16, 2017

By Edward Golding, CFA, MBA
Portfolio Manager, North American Equities

One of the greatest temptations in investing is trying to make a quick buck. Who hasn’t wished in hindsight that they’d bought the proverbial “ten bagger” and then sold at its peak? Of course, the realities of investing aren’t so simple—and sometimes stocks do the exact opposite of what you want them to do.

Even the best stocks can have a poor start

Recently I wrote about the high growth rates of the FAANG (Facebook, Amazon, Apple, Netflix and Google) stocks, and how they’re the main drivers of today’s stock market returns. While the FAANGs continue to drive total equity returns, they have corrected sharply over the last week. Since June 9, FAANG stocks are down between 5% and 9%. This type of volatility can lead to errors for investors who take a short-term view of the market, rather than focusing on the long-term merits of a business. 

For Facebook in particular, we continue to believe in the long-term company fundamentals, though when we purchased it for our clients in the MD American Growth Fund back in late May 2012, its growth potential wasn’t so obvious.

Facebook had held its initial public offering (IPO) on May 18, 2012—one of the largest IPOs in technology history, as the company achieved a peak market capitalization of over $104 billion. The IPO price for the stock was set at $38 on that first day of trading and we initiated our purchase of Facebook on May 23 at $32.90 per share, at a small weighting of just 0.6% of the fund.

We were confident that Facebook was poised to become a global leader in social media and would be the go-to digital space for corporate advertisers. While still in its infancy, we believed mobile advertising was the true growth engine for the company, and at the time, it was still largely untapped as most revenues were generated through the desktop platform.

While we were bullish on the prospects for Facebook, it turned out that some other investors held a different view. Thanks to skepticism about the prospects for advertising revenue growth on the mobile platform, the stock declined by over 46% from our purchase price to just under $18 per share by September 2012. 

Holding firm to our belief in company fundamentals

With half of our investment lost within this short time frame, we had the unenviable task of taking a closer look at our initial beliefs. Were future revenue projections for mobile advertising growth wrong?  Would the growth of monthly active users of the platform slow, or possibly decline? Was the business model more vulnerable to competitive threats than we had initially thought?

With an almost 50% drop from our purchase price, it would have been easy to just throw in the towel and move on. But our review of the company reassured us that we should maintain our confidence in Facebook. We consequently made additional purchases (to keep our allocation in the stock at the initial entry level of 0.6%) throughout the latter half of 2012 and the first half of 2013.

While Facebook’s stock price didn’t recover to our initial purchase price until July 2013, more than a year later, we remained patient and confident in our analysis—consistent with our long-term approach to investing. 

The case for holding declining stocks with strong fundamentals

As long-term equity investors, we don’t pay as much attention to the short-term movement of a stock, as we do to the long-run fundamentals of the business. And as investors, we’re not concerned about a company’s single quarter’s earnings report; we’re more concerned with issues like the long run growth rate of earnings and sales, improving profit margins, valuations, debt coverage levels, strategic direction, management and competitive threats to the business model.  Focusing on these types of long-term objectives and guideposts puts us in a better position to improve our clients’ financial outcomes.

If an investor remained fully invested in the S&P 500 Index from January 1988 through to June 2017, they would have earned an annualized return of 10.23% (USD).  However, if the investor missed only the 10 best days in the market, their rate of return would have been only 7.07%. That’s over 3% annualized lost for the investor, as some of the best single day returns occurred when the market volatility was high and many investors chose to sell out of the market.

A long-term view

Back to Facebook. While our initial timing could not possibly have been worse, our thesis was spot on. Today Facebook has increased its revenue by a compound annual growth rate of almost 50% and mobile advertising accounts for about 85% of total revenues. Worldwide monthly users currently total 1.95 billion and advertisers now consider the use of Facebook critical to reaching their target customers.

As of June 15, Facebook is trading at almost $149 per share, up an incredible 353% from our initial purchase price—an accomplishment achieved only by our long-term investment approach, and avoidance of market timing.

We use Facebook as an example here to highlight the perils of short-term thinking, but it’s important to keep in mind that even the most rigorous analysis and best long-term view can lead to a loss on a particular stock. We’re not immune to this. But our long-term thinking minimizes an additional layer of risk by trying to time a stock’s entry and exit.

Rather than worrying about missing out on the next “ten bagger”, we’re focused on generating a healthy return over the long run. 

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