Last week, one of the largest single value destruction events occurred in market history. Meta Platforms, formerly known as Facebook, reported their 4th quarter earnings, and while the results were strong, the company issued forward guidance below Wall Street analyst estimates. This caused the stock price to fall 26% in a single day, eliminating ~$250B of the company's market value—an astronomical amount for one of the largest companies in the world. As a result, many investors might be asking why, or even how, did this happen?
There is no single answer to this question, and as a result, many narratives may be spun to explain the situation. Regardless, the purpose of this newsletter is not to discuss the merits of any single investment or to evaluate companies' financial results and valuations. However, we do endeavor to bring to light the discipline and process of sound investment decisions that protect and compound wealth.
With that said, many investors will conflate a good company with a good investment. A single factor model such as this can cause tremendous investment mistakes and loss of capital because it fails to incorporate the most crucial aspect of whether an investment is a good one or a bad one - Price. Ultimately, the merits of an investment is determined by its value, and the cost of that value is the price paid.
1) Meta Platforms - Priced For Perfection
Meta Last Six Months Stock Price
In the case of Meta, as an investment, it appears to have been priced for perfection before its earnings announcement. Evidence for this can be found by understanding that its forward revenue guidance for 2022 of $27B-$29B, which misses consensus analyst estimates of $30.27B, caused the company to lose a quarter of its value overnight. Investors had been expecting the company to continue experiencing its stellar, if not perfect, performance from '20 & '21 into '22 - and it appears that that will not be the case. The company is still a good company, most companies would love to have Meta's growth prospects, but the investment at its previous price was clearly not, at least for now.
This is important not only from a personal standpoint, i.e., being aware and managing concentrated equity risk on your personal balance sheet, but also at the broader market level. The S&P 500 index (The Stock Market) is a market capitalization-weighted index, which means the larger the company market cap, the larger the companies representation in the index. For example, at a market cap of $615.35B, Meta holds a weight in the index of 1.47%. Compare this with IPG Photonics Corporation, the smallest in the index, at a market cap of $8.04B, and holds a weight of .014% in the index. What this means is the price performance of Meta will have a much larger impact on the market than the price performance of IPG Photonics, 105 times the impact, to be precise. That is how the market works.
2) FAANG Stock Performance
Meta (FB), Amazon (AMZN), Apple (AAPL), Netflix (NFLX), and Alphabet (GOOG)
Further, because companies like Meta (FAANG Stocks) have done so well over the last decade, the index has become ever-more concentrated in a handful of stocks. As I write this, the top 10 holdings by weight in the index now represent ~30% of the S&P 500. Compare this to 2010, when the top 10 holdings only represented ~19% of the index. Because of the market cap-weighted dynamic of the market, it is a common phenomenon for high concentration in a few stocks in the latter stages of bull markets to occur. In fact, per exhibit 3 in the article linked above, the last time the S&P 500 became so concentrated was in 2000, when the top ten holdings represented ~26% of the market. And that is precisely what has been happening over the last handful of years.
3) S&P 500 Weighting Concentration
Weightings of the Top 10 Holdings
So why is this important? Many investors hold concentrated equity positions in their portfolios and on their balance sheets through their company's equity compensation. And through this, many have experienced out-sized returns, which can naturally cause an emotional attachment to the investment. This dynamic can blind one from making the proper investment decisions to protect and compound one's wealth through disciplined divestment and diversification. As a result, these positions become larger as a percentage of one's net-worth and expose them to even more idiosyncratic single-stock risk. Not only is this occurring on individual balance sheets, but it has also been developing at the broad market index level as well, which compounds the risks.
The Bottom Line: Meta is a case study in risk management of a security that had been priced for perfection. As investors, we must understand that past performance is no guarantee of future returns. To properly risk manage one's portfolio requires decoupling any emotional attachment to an investment in the pursuit of successfully protecting and compounding wealth over the long term.