The wild fluctuations in markets in the last week have increased the doubts over long-standing beliefs investors have held regarding the top tech giants.
The first was the idea that all of the major tech companies have the same attributes. In the course of the pandemic, the shares of the major tech firms including Facebook (now Meta Platforms), Apple, Amazon, Netflix, Google, et al generally changed in unison, or at the very least, to the exact same level.
Since the beginning of the outbreak in 2020, until the peak of their shares last November, shares for companies belonging to the “FAANG” companies, as the group is known increased by around 200 percent as restrictions and incentives to stay at home witnessed a huge rise in online activity.
Another was the belief that the effects of networks and the size of the technology giants were nearly invulnerable and ensured growth. The more people used their services, the more people were likely to join them that were generating ever-increasing size and profits. To borrow Warren Buffett’s term firms like Facebook, Apple, Google and Amazon were believed to have large “moats”.
This led to growth nearly in perpetuity, being taken into account in the price for shares.
At the end of last year, the FAANG shares were trading at an average of 42 times. With no earnings growth, it could take investors 42 years to recover their investment and investors were taking advantage of several, many years of extremely strong and uninterrupted earnings growth into these share prices.
When the price of Facebook’s share plummeted on Thursday of last week at New York, shedding more than $US230 billion ($325 billion) of market capitalization and shattering some of those misconceptions.
The reality that the market value of Amazon was up nearly the same amount as Facebook’s dropped on Thursday, following the release of an impressive financial report showed that not all tech companies are alike. The growth in Amazon’s value was the largest single-day gain ever recorded and Facebook’s loss was the biggest one-day loss ever recorded.
The fall in Facebook’s share price was not due to just the financial results being poor, but the company’s first decline in active users’ numbers nearly 20 years in existence.
It would have raised a serious question about the ability of Facebook to keep its lead in social media – it mentioned the threat of TikTok and others in the autumn – but the situation was made worse by the fact that Apple’s privacy policies that permit its users to opt-out of ad-tracking, could cost the company $US10 billion.
Share price ($US)
The effects of network effect of Facebook’s constantly growing (until this point) user base has morphed into the company’s revenue base when its users traded freely and without a conscious thought — or not knowing their privacy to gain accessibility to its platform. The user base and revenue base have diminished which raises the possibility that the effects of the network could be reversed.
The Facebook experience definitely undermines the idea that the effects of its network which had driven its growth would continue to ensure its unstoppable and unchallengeable dominance, as well as self-sustaining growth.
It also highlights the fact that when a company with a high multiple fails to understand the simple maths of shifting to a lower multiplication, that the company is crushed.
Facebook isn’t unique. The first-mover advantage that drove Netflix’s growth and allowed it to invest in content at a an amount that was far higher than its predecessors has been eroded by the size and variety of rivals (including the major Hollywood studios) that have flooded the market for streaming.
The conclusion of the pandemic surge in streaming services’ consumption has increased the difficulty for Netflix of ensuring that it continues to expand its base of subscribers at the same levels at which it has been growing before.
In addition, Amazon which has a greater variety of companies than Facebook is now facing competition from retail stores, both large and small, that are reacting to the shift in consumer buying habits and the risk that Amazon could pose for their businesses and in fact their very existence. Other tech giants are taking advantage of Amazon’s lucrative cloud-based services.
The Facebook story suggests that the walls around big technology aren’t quite as strong or as safe as regulators and investors were thinking. their growth indefinitely can’t take for granted or incorporated into shares.
It’s especially the case that, in contrast to the last two years – – and for over 10 years, the interest rates are rising, and the liquidity of the financial system will likely shrink.
If interest rates increase and the discount rate is employed to determine the value of anticipated cash flows in the future. If rates are increasing and the expectations of investors are reduced, then declines in shares, such as the one which wiped out Facebook shares on Thursday will be inevitable.
The rise in rates and the beginning of a diminution of the massive liquid reserves that have been flowing around the global finance system ever since the financial crisis in 2008 should be a sign that the exaggerated multiples that shares have been traded since 2008 will return to something that is closer to normal levels.
At around 24 times earnings, the US could be lower than the 30-plus number one year ago the rates are likely to remain fairly low, even if there are five or four rate increases across the US this year, and liquidity is expected to be fairly plentiful in comparison to past trends in the coming years The price-earnings ratio remains well above the mid-teens of its historical average.
The major tech companies have offered an unbeatable floor for markets through the pandemic, however, the experience that they have had with Facebook, Netflix, PayPal, and others has highlighted the differences between them as well as their vulnerability to shares to any change either externally or internally, which could undermine the investment philosophy of constant high and unchallenged growth that will continue to grow into the future.
This makes the market less stable and riskier. This could make investors more cautious. This isn’t necessarily a bad trend.