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Why You Should “Unfriend” Facebook Stock

“Facebook is dead to me.”

This startling observation (accompanied by an eye roll) came yesterday from a teenager in our extended family, after I asked if she had been following my Facebook news feed. When I pressed her further, she told me that the social media platform was being ruined by “narcissistic old farts” like me.

Gee, thanks kid. But her jaded comments got me to thinking.

A handful of technology stocks continue to drive the broader indices to new highs, which sets up this aging and overvalued bull market for a fall. On the list of endangered stocks, you could include any over-hyped “FANG” denizen: Facebook (NSDQ: FB), Apple (NSDQ: AAPL), Netflix (NSDQ: NFLX), or Google, which is now Alphabet (NSDQ: GOOGL).

As I’ll explain, I think Facebook poses the worst danger, because of its nosebleed valuation and inherent weaknesses. Wall Street’s complacency over Facebook’s unsustainable rise only heightens the risk.

House of cards?

Since 2012, S&P 500 earnings have gained only 12%, while the S&P 500 gained 80%. For almost three years, earnings for S&P 500 corporations have fallen while the major indices continue to break records.

So far this year, six stocks have produced 40% of the gains of the S&P 500 — the four FANG stocks plus Amazon (NSDQ: AMZN) and Microsoft (NSDQ: MSFT).

I expect this house of cards to tumble later in 2017, as the Federal Reserve hikes interest rates, economic growth slows, and overblown expectations for many tech stocks collide with reality. What’s more, the inability of the Trump administration to get anything done will increasingly disillusion investors.

Perhaps billionaire Peter Thiel knows something we don’t. During the last week, the Silicon Valley entrepreneur has sold a huge chunk of Facebook shares.

Thiel was Facebook’s first major institutional investor and he remains on Facebook’s board. However, according to securities documents filed on July 28, Thiel sold 60,316 of his class A shares, worth $10.4 million. No reason was given.

Regardless, Facebook is ostensibly thriving. Year to date, FB shares are up nearly 48%, compared to about 11% for the S&P 500. Company founder and CEO Mark Zuckerberg seems to know what he’s doing. As the progenitor of social media, Facebook is heavily investing in the purchase of promising new technology companies, with an emphasis on virtual reality and artificial intelligence.

In the third quarter of 2012, the number of active Facebook users surpassed 1 billion, making Facebook the first social network ever to do so. As of the second quarter of 2017, Facebook had 2 billion monthly active users (defined as those which have logged onto Facebook during the last 30 days). Facebook is now the most popular social network worldwide.

Here’s my major beef with Facebook: the company sports a whopping market cap of $492.2 billion, but it doesn’t make a product. Zuckerberg’s brainchild, conceived in a Harvard dorm room, currently is worth more than Exxon Mobil (NYSE: XOM) at $338.7 billion; General Electric (NYSE: GE) at $221 billion; and Coca-Cola (NYSE: KO) at $194 billion. That seems crazy to me.

Facebook talks a good game about leading-edge forays, but many of the company’s pronouncements smack of corporate spin that’s dutifully regurgitated by fawning analysts. What’s more, the verdict is out as to whether Facebook ads really work and it’s these ads that are the source of the company’s revenue. Meanwhile, Facebook is banned in China, which closes the door to vast opportunities for growth.

Millennials are leaving Facebook at the rate of about 1 million a year, for “cooler” social media venues such as Snapchat (NYSE: SNAP). After its ballyhooed initial public offering this year, Snapchat is encountering problems of its own, but that only proves my point: expectations in the social media realm are absurdly out of whack with the fundamentals.

Facebook’s energy source: media hype…

Facebook reported second-quarter fiscal 2017 earnings of $3.89 billion, or earnings per share (EPS) of $1.32, up from $2.28 billion, or EPS of 78 cents, in the same period a year ago. The average analyst expectation was for EPS of $1.12.

The talking heads on financial television gushed over Facebook’s latest operating results, energizing the share price. However, what CNBC and the other faux news channels don’t tell you is that Facebook’s active users number is self-reported and unaudited.

Sure, Facebook supposedly has more than 2 billion monthly active users subject to the ads it presents. But most of these users are Millennials, a customer base that’s fickle and suffers from a collective short attention span. Folks of that generation (and younger) increasingly shun Facebook.

According to a recent survey by media analysis firm Bridge Ratings, the number of people who report using Facebook has declined from 2012-2017, with the biggest fall-off coming from people between the ages of 35 and 44. In 2012, 25% of that age group reported not going on Facebook; the number stands at 41% today.

Facebook attests that its overall user number keeps exceeding estimates every quarter, which seems rather convenient because the number comes from Facebook itself. Advertising is the source of Facebook’s revenue and yet businesses increasingly question the efficacy of those ads. This year, the trade journal Small Business Trends released a survey of more than 2,600 small-business owners, revealing that 62% of respondents believe Facebook ads don’t work.

Facebook now sports an absurdly high forward 12-month price-to-earnings ratio (P/E) of 32.2, compared to the average forward P/E of 19.9 for the S&P 500. The S&P 500 itself is overvalued and poised for a correction. All it would take is for one disruptive technology or less-than-stellar earnings report to send Facebook crashing to earth.

Jim Pearce, chief investment strategist of Personal Finance, puts it this way:

“Sooner or later the small group of momentum stocks that have been leading the market higher will face their day of reckoning…

What this may boil down to is a very expensive game of musical chairs. Companies priced at moderate earnings multiples that remain profitable will attract investor capital, while those that are priced at a premium to the market and come up short on earnings will see their share prices take a beating as investors abandon them in favor of more reasonably priced stocks.”

Human behaviors can resemble viruses: they spring up, spread infectiously among people, then eventually die out. Increasing numbers of younger people have developed an “immunity” to the Facebook virus; I’m willing to bet that advertisers start gaining immunity and lose interest as well. Peter Thiel got rich from Facebook; later-stage investors won’t.

If you’re a Facebook adherent, my analysis probably has annoyed you. I enjoy receiving reader letters, so give me your best shot: mailbag@investingdaily.com — John Persinos

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Jim has put together a proprietary trading system that quickly and predictably multiplies the gains of ordinary stocks. By following just a few elegantly simple steps, his investment method allows you to take regular stock movements of 8%, 17%, or 34% and amplify them to generate profits of 100%, 300%, or even 800%.

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