Last Wednesday, the street was disappointed by Facebook (FB) earnings report. Below are a few important takeaways from the tech giant’s quarterly results:
- Expect revenue growth to slow down: While it was growing year-over-year (YOY) around 40+%, revenue growth is expected to slow down to the 25% range. One main driver for slower revenue growth is flat monthly active user (MAU) growth in the U.S. and Canada, which are FB’s most profitable markets. It will continue to grow its MAUs going forward, but mostly in emerging economies, which are much less profitable.
- Expenses are increasing: The regulation scrutiny means FB needs to spend more to police its website. Its operating margin will decrease from the 45% range to the 35% range.
Its share price decreased by 20% on Thursday, eviscerating its market cap by $120 billion - the largest loss of market value in a day for a U.S. company. The second and third largest losses of market value in a day were Intel and Microsoft in 2000, dropping $91 billion and $77 billion, respectively.
The selloff of FB triggered a sharp reversal between value and growth stocks. As you can see in the chart, value stocks are at the cheapest level compared to growth stocks in the last 15 years. In a market with a shortage of growth opportunities, investors pay up for secular growth names such as the famous FAANG (Facebook, Amazon, Apple, Netflix and Google) stocks.
I believe it’s time to be cautious about growth stocks and add some value exposure in the portfolio. From a positioning perspective, overweight in FAANG + BAT (Bidu, Alibaba and Tencent) is the most crowded trade in the market based on a July Bank of America Merrill Lynch Fund Managers Survey. From a market cycle perspective, when the cycle turns, the leaders of the bull market usually sell off much more; the laggards tend to outperform during the downturn. We are more than one year into the Federal Reserve’s tightening cycle, and now the European Central Bank (ECB) and Bank of Japan (BOJ) are expected to follow; therefore, it could be viewed as timely to book some gains in growth, and move them to value stocks.
Growing popularity in index investing is another reason. The S&P 500 Index used to be a fairly diversified index. After several years of outperformance in the technology sector and FAANG, however, the S&P 500 Index has 26% in the technology sector and 11% in FAANG stocks.
Growth stocks have outperformed value stocks over the last few years. By historical standards, value stocks are very inexpensive compared to growth stocks. It may be a prudent move to slowly rotate out of growth names and into value stocks in the coming months.
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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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