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By The Numbers #18

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A By The Numbers wherein I decline to discuss the numbers in the news.

Facebook and Twitter have been all over the news this week following drops in the stock prices after their earnings announcements.

Rule #1: Don’t write a hot take about the stock market.

Rule #2: Don’t read a hot take about the stock market.

Rule #3: If you’re going to read a hot take about the stock market, here are some things to keep in mind:

  • Stock price is driven by supply and demand. If more people want to own the stock, the stock price will rise. If fewer people want to own it, the price will fall.
  • Different stocks create demand for different reasons. Some investors look for appreciation in the stock price, while others seek dividends. Some investors are interested in short-term movements of the stock, while others are interested in long-term prospects. Some investors are interested in buying market-composite portfolios and some investors seek out advantageously priced companies.
  • All investors are (or should be) interested in the risk-reward prospects of their investments, but their measurements and time horizons of that risk and reward may vary. Different investors can view the same stock differently.
  • A primary driver of these risk-reward considerations are investors’ expectations of future cash flow. The news that companies provide during their earnings releases lets investors know whether the company’s current and projected future performance is aligned with the investors’ expectations. (This is why a company can have what seem like reasonable results that are met poorly by the market; if the results were not as strong as the investors expected, demand for the stock may be impacted even if the results were “good” absent the context of expectations.)
  • In particular, expectations may be dampened if the company announces:
    • news that indicates future cash flows will be smaller than previously assumed or delayed in their timing (e.g. lower revenue, lower profit, reduced growth rates, etc)
    • news that indicates there is additional operational risk that impact the certainty of the cash flows (e.g. changes to business environment, competitive landscape, etc. – the classic PESTLE analysis items)

Stock price and market cap can be a useful shorthand to talk about the impact of underlying fundamentals, but some of the hot takes this week are a little much. So no, I don’t think it makes sense to talk about this as the market calling in a debt on years of privacy controversies. I don’t care about how much money Mark Zuckerberg lost on paper in a day. I think everyone who is calling this the start of the second collapse of the dot-com bubble or an impetus to move to bitcoin should probably slow their roll.

That’s not to say that the market effects or the underlying concerns that drove the price changes aren’t real. They are. Discussing the changes to operations and the environments in which these companies are operating is so much more nuanced and interesting than focusing on the change in the stock price itself. Talking about lost billions may feel significant, but remember that the stock price is the symptom and not the cause.

So specific to this situation, some things to keep in mind:

  • the companies announced declines in users, which drives revenues, which drives profits, which drives cash flows.
  • the companies announced increased investment in security and self-regulation, which at least in the short-term can impact profitability and cash flow (though, this is an instance where those interested in the long-term health of the platform may be at odds with those who care about short-term maximization of the firm value.)
  • the companies indicated that the geopolitical and legal environments in which the companies operate (vis-à-vis privacy laws and regulations) may damper potential cash flows and add increased risk to the operating model.
  • markets are often called irrational; part of this is human emotion which can indeed be irrational, and part of this is that it’s hard to weigh the values/priorities of other investors; if different investors have different motives, it’s hard to assign a binary rational/irrational judgement to everyone’s response because people may not be using the same criteria to assess performance.

These stock declines are indeed suboptimal, but there is more nuance to the situation than the hot takes on social media and press headlines have indicated. Our view about the companies’ operations should be broader than the recent stock price moves.

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