Stock Investing

Facebook's share price crash has dragged down tech stocks and overshadowed a very positive earnings season for Amazon, Alphabet and Apple.
By James Gard | 03/08/18

 Facebook's (FB) share price crash has been the biggest story of this quarter's tech earnings season, overshadowing strong performances from  Amazon (AMZN),  Apple (AAPL) and Google parent company  Alphabet (GOOGL).

About the Author
James Gard is subeditor for Morningstar.co.uk.

The biggest question is whether Facebook's problems will trigger an existential crisis for FAANG stocks in general, or lead to an unbridgeable divide between tech "winners" such as Amazon and the social media giants of Facebook and  Twitter (TWTR).

The bearish argument is that tech stocks have propelled global markets higher in recent years. With the trade dispute between the United States and China escalating, and central banks tightening monetary policy, this protracted bull run is due for a correction. The bull argument is that companies like Amazon are consistently outperforming and deserve their high valuations.

The actual results released by Facebook were impressive, showing revenue growth of 42% year on year and net profits rising 31%. But investors instead focused on the warning from chief financial officer David Wehner that revenue growth rates and margins would fall in the second half of 2018.

The 11% rise in user numbers year on year was also below estimates. By the end of the day the company's stock had dropped 20%, a nearly US$119 billion loss in value that was Wall Street's biggest one-day decline.

A buying opportunity?

Is Facebook's fall a buying opportunity for those who have been standing on the sidelines during the multi-year tech rally? Not according to Morningstar analyst Ali Mogharabi. While saying that Facebook's shares are now slightly undervalued, he recommends that investors seek a greater margin of safety before taking the plunge, suggesting that a share price of US$150-160 would be the enticing range.

However, Mogharabi believes that the current malaise at Facebook is a "bump in the road" before the firm "realises return on its investments in content quality management and data security in 2020 and beyond, resulting in longer-term margin expansion."

Twitter followed Facebook in reporting results, and it chose a bad time to report a drop in the growth of monthly active users and warn of a drop in users in the third quarter. Analysts have fretted about Twitter's user growth in many previous quarters but this time they lined up to downgrade their price forecasts for the stock. Twitter shares, like Facebook, lost 20% on the day of the results, and shed nearly 10% further on Monday.

The Nasdaq Index has been dragged down since Facebook's results, as have FAANG-focused indices and ETFs. Despite stellar results from Amazon and Alphabet, their shares have suffered from the abrupt change in sentiment away from tech stocks.

Apple wins trillion-dollar race

Among the tech winners, Apple just became the world's first trillion-dollar company, with Amazon and Alphabet not far behind. All three beat Wall Street consensus figures. Amazon did this in spectacular fashion, posting an increase in earnings per share of over 1,000%, with Amazon Web Services driving much of the growth.

"Even the most ardent Amazon bear would have a hard time finding negatives from its second-quarter update," says Morningstar analyst R.J. Hottovy, announcing plans to raise the fair value estimate for the company's shares to US$2,200 from US$1,900, against a current share price of US$1,777. Significantly, Amazon also raised profit forecasts for the third quarter.

Among the FAANGS, Amazon is the only stock to be rated 4-stars by Morningstar equity analysts, meaning that they consider it to be undervalued.

A rise in Apple's share price on Thursday drove the iPhone maker's market capitalisation up just above the trillion-dollar mark. Quarterly revenue and profits beat estimates, as did iPhone selling prices -- although the 41.8 million phones sold was below forecasts.

Morningstar's Abhinav Davuluri maintained the US$175 a share fair value estimate for Apple, arguing that prospective investors should wait for any share price fall before committing.

Noting that the company posted a fourth straight quarter of double-digit revenue growth, "loyal iPhone users and many new customers in emerging regions have flocked to the iPhone X, 8, and 8 Plus," Davuluri says.

Google parent company Alphabet put in another strong performance with a 26% rise in revenue on the year to US$32.7 billion. Advertising revenue, helped by growth in YouTube ads and mobile ad spending, was up by a similar amount year on year.

As a result, Morningstar analysts upgraded their fair value estimate for the stock to US$1,300 a share -- above a current price of US$1,227: "Alphabet shares continue to trade in three-star territory; however, we would be buyers of this stock on any pullback."

Netflix still overvalued

Finally,  Netflix (NFLX), whose share price has had a stunning run in recent years but has shed around 10% since the most recent earnings release, is rated 1-star by Morningstar, which means that it is significantly overvalued. After the most recent set of results, analysts raised their fair value estimate for the stock but said that Netflix faces stiff competition from new entrants, notably  Disney (DIS), which plan to undercut Netflix's pricing.

Equity analyst Neil Macker argues that the cost of spending on content will continue to eat away the company's profits. "We believe that the current stock price reflects a final state in which Netflix is either the only major content provider or part of a duopoly with Amazon, particularly for serial or TV content," he adds.

What does this recent set of results mean for investors? The FAANG acronym could be under threat, leaving just AAA -- Amazon, Apple and Alphabet. As Morningstar ratings and fair value estimates show, the high valuations of tech stocks mean that any nasty surprises lead to significant share price falls. The NYSE FAANG index itself is off 10% from its peak, meaning that it is in correction territory.

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