CHAPEL HILL, N.C. — Things very well could get worse for Facebook’s stock before they get better.
I base this prediction on an analysis of the forecasts of Wall Street analysts who follow Facebook FB, +0.55%, who — like other Wall Street analysts — tend to behave in herd-like fashion. It looks as though the recent wave of analyst downgrades, which began earlier this year, still has further to go.
There are a variety of reasons for analysts’ herding behavior, as I explained in a column in early July in which I concluded that “Wall Street’s outlook on Facebook is about to get worse.” In a nutshell, however, the historical pattern is for a downgrade from one Facebook analyst to more likely be followed by another downgrade from another analyst than to be followed by an upgrade. The same is true for analyst upgrades.
The recent downgrade wave for Facebook began in April of this year, as you can see from the chart above. At the end of March, 73% of Wall Street analysts in the FactSet database were projecting that Facebook earnings per share would be revised upward. This percentage has since dropped into the 20%-to-25% range, where it remains today.
If past patterns are upheld, this percentage will drop to an even lower level before the next analyst upgrade wave begins. In the summer of 2018, as you can see, this percentage actually fell to zero.
Note that a continuation of the analyst downgrade wave doesn’t mean that the news about Facebook is itself going to get worse before it gets better. There is a difference between factors that objectively impact Facebook earnings and how analysts choose to analyze those factors. It’s the interpretations that come in waves, not those developments.
Needless to say, it’s those interpretations that impact the short-term direction of Facebook’s stock.
Since April, an increasing number of analysts have chosen to put a negative spin on Facebook news. And that news certainly appears to be unfavorable. The Federal Trade Commission this summer levied the largest fine ever imposed by the FTC (for Facebook’s privacy practices), for example, and this past week the Justice Department announced that it was opening an antitrust investigation into the company.
But this negative spin isn’t preordained. It’s possible to argue, as a few commentators have, that a $5 billion fine is not that damaging to a company that had net income of over $22 billion in 2018, and whose stock price is based on an expectation of rapid earnings growth over many years into the future. And the Justice Department’s antitrust investigation comes on top of one previously launched by the FTC, so it doesn’t necessarily break new ground.
I am not taking a position on which interpretations are correct, I hasten to add. My point is that analysts have a choice as to how to interpret company developments. Recently, positive spins have been the exception rather than the rule, as evidenced by the preponderance of analyst downgrades. At some point the tide will turn, and a new, more upbeat narrative will gradually capture the analyst community.
At that point, Facebook’s stock will begin to ride a wave of analyst upgrades.
We’re just not there yet.
Mark Hulbert is a regular contributor to MarketWatch. He doesn’t own any Facebook shares. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org.