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Editor’s Note: Today we’re bringing you a guest editorial from TradeSmith Chief Research Officer and TradeSmith Decoder Editor Justice Clark Litle. We think you’ll appreciate his research and analysis. Keith will be back on Monday with more of his market insights.
When Netflix (NFLX) gapped down 21.8% lower on Jan. 21, investors were shaken by the spectacle of a $200-billion-plus FANG name losing a fifth of its market cap overnight.
But that was just a warm-up.
On Thursday of this week (Feb. 3), Facebook — now known as Meta Platforms Inc. (FB) — gapped down 24.2%, losing nearly a quarter of its market cap (more than $200 billion) in a single overnight session.
The Meta drop broke records for a single-day earnings loss and represented a larger wipeout than Netflix’s entire market cap.
But the Meta wipeout was actually even worse than that, because multiple other companies within the Big Tech universe saw large drops in sympathy, and the entire Nasdaq was pulled into the red.
For example, in the wake of the Meta Platforms drop, Snap Inc. (SNAP) gapped down 19.7%; Spotify (SPOT) gapped down 14.5%; and Block (formerly Square [SQ]) and Twitter (TWTR) both gapped down roughly 7%.
It should also be noted that PayPal (PYPL) is in a similar boat, falling 24.9% in a single day on Feb. 2.
The ominous thing is that all these companies have a similar problem — and it isn’t related to the Federal Reserve or interest rates.
The Federal Reserve’s hiking cycle is a problem, but this issue is potentially even worse.
All of these companies are dealing with a toxic cocktail of saturated competition, growth deceleration prospects, and overinflated expectations being violently adjusted downward.
These companies are still growth stocks. The problem is that, for the most part, they are no longer growing as quickly as they did in the past.
Think of a car that goes from 80 miles an hour down to 50 miles an hour: The car is still traveling forward, but not as quickly.
Then, too, slower growth in the future means slower revenue accumulation, which in turn means lower long-term profits.
The Metaverse is Crowded and ExpensiveMeta Platforms is at the center of this phenomenon because after years and years of double-digit traffic growth, adding tens of millions of users every year, the tide has turned.
As part of its first quarter 2022 earnings forecast, FB executives anticipated year-over-year growth between 3% and 11%. Any number that comes in below 11% would represent the lowest year-over-year growth in the company’s existence to date.
This is not just a problem for the coming quarter, but for all future quarters: Mark Zuckerberg’s creation is reaching full maturity, and its growth overall could soon peak.
Then, too, FB is facing saturated competition on all sides.
In the same manner Netflix is now fighting for attention in an extremely crowded field — there are more media streaming services than one can count — Facebook and Instagram are seeing increasing competition from attention-grabbing upstarts like TikTok, Roblox, Twitch, and various crypto-themed metaverse hangouts.
This is a double whammy for FB: Even as the company sees lower user engagement due to competitive attention sources, Zuckerberg is ramping up huge expenditures in an effort to own the future metaverse (the supposed next big thing after which the parent company was renamed).
In 2021, the company’s Reality Labs division — a unit that makes virtual reality goggles, smart glasses, and other futuristic, metaverse-type stuff — racked up a whopping $10 billion in losses, and will likely be a cash furnace (burning up billions) for many years to come.
In some ways this is the worst of all worlds for FB investors: The company is seeing the most ominous growth deceleration in its history, with significant competition pressing in (TikTok is no small rival), even as the new metaverse initiative promises to be a very expensive gamble. Like self-driving car hype in 2010, and artificial intelligence hype long before that, the technical details of real-world implementation could take a very long time to catch up. (It isn’t at all clear that the metaverse will actually take off, or that FB will be a winner if it does.)
SNAP fell so hard in sympathy with FB because SNAP is also facing saturated competition pressure, and will likely also be forced to spend heavily if it wants to remain competitive as metaverse buzz ramps up.
Digital Payments and Streaming are Crowded TooIn the digital payments space, PYPL had a disastrous earnings report this week — shedding nearly a quarter of its value the following day — in part because growth was below expectations, fraudulent activity was shockingly high, and competitors are pressing in on all sides (a common theme).
On the PayPal earnings call, management gave a forecast of 15% to 17% revenue growth for 2022 and 19% to 22% growth in total payments volume. That sounds nice and growth-worthy, except payment volume growth in 2021 was 33%.
PayPal added to the earnings call gloom by noting that the company had identified a whopping 4.5 million fraudulent accounts, further adding that a fair number of new accounts that were opened during the pandemic were for one-time transactions or had otherwise gone dormant.
Then, too, PayPal is more of a brand name for Generation X than millennials: The hip and easy way to send payments these days is more along the lines of Venmo or Cash App, with new entrants gaining ground and PayPal struggling to maintain its growth path.
And yet, even millennial-friendly payment services, like Block (formerly Square), could struggle mightily from here due to inflated expectations and fierce competition. (Valuation multiples tend not to matter when the bulls are in charge, but once the pendulum swings, as it always eventually does, they matter a lot.)
In some ways, too, the 14.5% sympathy gap lower in SPOT was the most shocking bit of FB-related turbulence, because SPOT didn’t even miss its targets. The numbers were more or less in line with expectations, but then again, the competition is fierce and SPOT is still a money-losing company — not a good thing to be when financial conditions are tightening and interest rates are rising.
All in all, this is the kind of thing that happens at the tail end of market cycles: Companies that were once red-hot growth names start to cool as the burden of competition catches up with them.
And if you find all the red ink in growth and tech names depressing — in our view, there is a lot more to come — we would recommend casting your attention to energy stocks. The oil majors are gushing cash again (Exxon just had a blockbuster quarter), and the S&P 500 energy sector remains cheap.