The beginning of the end for Facebook (and probably the FANG stocks)

By | March 26, 2018

Before we start, due to various definitions of FANG stocks everywhere, we define them as Facebook, Amazon, Netflix and Google (Alphabet).

Since we entered the information age, wealth was created not mostly from physical goods or natural resources. Wealth comes more and more from digital resources. That was the reason why “American garages” were the most amazing places ever: Apple, Amazon etc. were all conceived in someone’s garage. You probably never will be able to see a steel mill or traditional car company started in someone’s garage. The reason was simple: nowadays the new industry is primarily based on digital goods and not hard, physical goods. These internet-based companies could grow based on existing investments in infrastructure: Amazon did not build the credit card payment network; Google did not build the internet; Netflix did not build the telecom waves that they use to stream movies to users’ phone/tablet; Facebook will not exist if no computers or network connections exist in colleges students’ dorms.

That was another reason that you see fewer and fewer wars these days: because the return is not as great as before. Indeed, when crude oil was north of $100/barrel, controlling an oil field that can produce 10 million barrels over its lifetime means you controlled almost $1billion worth of assets. However when the importance of crude oil diminished over time, not just the price of crude oil but also the economic importance when alternative energy is taking more and more share in economic activities, it is harder to justify to spend a few hundred million dollars to conquer a country or region that is rich in oil reserve.

If someone decides to occupy Silicon Valley, taking it away from US, the companies or people working there can go somewhere else. Data or program can easily be replicated in another location, and the value of physically controlling Silicon Valley then becomes much less.

In today’s world, data and other digital knowledge are probably the most valuable assets. That was the reason companies in these fields are valued highly: not only they deliver high margin (because they don’t need to invest in infrastructure that supports the business in the basic way: i.e. the internet, the credit card payment network, the logistic delivery network), they also benefited from the early mover advantage that the competition hasn’t fully caught up and they are expanding their market share in a previously non-existent market.

However, just like any industry in history, they will become victims of their own success. When the industry emerges initially, people haven’t fully grasped the implication of such new businesses. When the companies play more and more important role in economic activities, they will draw attention: privacy concerns, monopoly over certain market, neglected risks like cyber attacks and users data safety issues and transparency issues. Such attentions eventually will draw regulators’ interests to introduce new laws and regulations to protect consumers from certain potential misuse of monopoly positions or users’ personal data that may be used in a way that is not legal or ethical.

Another threat comes from competitors into such space. This is economy-101. Any companies or industries that enjoy consistent high margin and fast expansion, will draw new comers to this space which will overtime diminish their market position thus lower the return on equity of these companies. This was the result of law of diminishing returns.

Facebook investors learnt this lesson the hard way in the past week: their shares declined 14% in one week due to the scandal related to Facebook selling users’ data without consent to Cambridge Analytics. We can be sure that soon there will be such laws introduced in this space to regulate and as a result, companies in this space need to invest more to safe-guard users’ data: a change that will lower their margin and slowdown their expansion.

Amazon has been battling various factors mentioned above for the past few years: lawmakers are introducing new tax laws so that they can capture the fruit from booming e-commerce. Competitors are making aggressive moves to get market shares away from Amazon (Wal-Mart’s and traditional retails’ online channels).

Public investors often invest companies based on “prospects”, not the price they pay. Facebook is still valued at around 30 times of their earnings, which implies that investors are paying for a company at a 3.3% earnings’ yield, essentially counting on its earning to maintain high 20% growth rate for years ahead. I hope those investors noticed that their users growth and hours spent on the site had the first negative growth in company’s history – an indication of effect of law of diminishing returns at work.

This is the beginning of the end for FANG stocks. Any value investors should stay away from any of the names and probably “hot technology” stocks in general.


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