Is Facebook the Perfect Short?

Lou Basenese

Tuesday, October 26, 2021

At some point, even the market’s strongest businesses and top gainers become attractive targets for short selling.

And that time might be coming for Facebook (FB).

It’s not because the company is in the middle of another public relations nightmare, after finding itself in one last week, too. (In case you missed it, here’s a replay of my appearance on Fox Business discussing this matter.)

And it’s not because the company’s results are deteriorating. To the contrary, the world’s largest social network just reported blowout results, posting sales growth of 35% and profit growth of 17%.

It’s simply because short selling opportunities regularly materialize in the market’s hottest stocks.

Here’s proof — and more importantly, here’s how to know the precise time to aggressively sell Facebook short…

Even the Highflyers Flop

To prove that even the market’s highest-flying stocks can crash and burn, at least temporarily, look no further than one of the best-performing stocks of the last few decades: Monster Beverage (MNST).

From 1995 to 2015, shares rose a staggering 105,000%, enough to turn $10,000 into more than $10 million.

Nevertheless, as The Motley Fool’s Morgan Housel notes, “It suffered four separate drops of 50% or more. It lost more than two-thirds of its value twice, and more than three-quarters once.”

Interestingly, for “buy and hold” investors, those stats underscore the need to be willing to endure gut-wrenching volatility without puking up shares prematurely (trailing stops be damned!). Otherwise, your gains would be much lower.

We’ll save that lesson for another day, though. Today we’re focusing on shorting.

Lest you think Monster was some abnormal example of neck-snapping volatility, think again.

Turns out, the 10 best-performing stocks over the last two decades or so all suffered multiple declines of 50% or more, according to Housel’s analysis.

So don’t be fooled. Facebook’s chart-topping run doesn’t immunize it against similar pullbacks.

Truth is, the company’s impressive 734% run-up from its IPO price has already been punctuated by one 50% decline.

(And before you ask — yes, my subscribers successfully played that downturn for a double-digit gain.)

Here’s why I’m convinced another one is coming. And more importantly, how to time and position your portfolio ahead of it.

Mobile Conquered

The last attractive time to short Facebook came right after its IPO.

You’ll recall, the company went public with much fanfare in May 2012, pricing shares at $38.

Within the first 106 days of trading, though, Facebook’s stock plummeted 53.8% to a low of $17.55, on September 4, 2012.

This wasn’t simply the result of overhyped IPO expectations meeting reality. A real problem existed: mobile.

Mobile simply didn’t exist yet as a revenue source for the company. And seeing that the world was going entirely mobile, if Facebook couldn’t make the transition, its business — and in turn, its stock — was doomed.

The rest is history, as we say.

Within a year, Facebook successfully started making the transition. Now it generates nearly 95% of revenue via mobile advertising.

Rightfully so, the stock responded in kind by consistently rallying to new-highs as the percentage of mobile revenue — and total revenue — kept climbing higher.

So what legitimate, fundamental issue is going to cause the next 50%-plus plunge for Facebook? Before I reveal the source, first we have to understand the core truth.

The Product is NOT the Business

An investment in Facebook is NOT an investment in a new-school social media platform. To the contrary, it’s an investment in a decidedly old-school business: advertising.

Long ago, COO Sheryl Sandberg confessed to Bloomberg BusinessWeek that the company sold out its users in favor of advertisers. Early in her tenure, she recounts that the top brass had a critical decision to make: Whether to make users or advertisers pay.

They chose the latter. As a result, the company is beholden to that group. Period. And such loyalty promises to topple the stock the next time an economic slowdown materializes.

Why? Because recessions sink advertisers.

Think about it. When times get tough, what’s the first thing the average company cuts? Advertising.

Despite countless studies indicating that’s the worst decision — from highly respected publications like the Harvard Business Review, McGraw-Hill and the North American Business Press — it still happens.

So when the next recession comes, Facebook’s going to be in trouble.

I guarantee many will argue that “this time will be different,” because Facebook has become an integral part of everyone’s everyday life. And I mean everyone, as the company reported 3.6 billion monthly users in the most recent quarter.

And during a recession, when unemployment increases, I’m sure that the time spent on Facebook will tick even higher!

That’s what we do when we have extra time on our hands. We look for distractions. Just like we did during the pandemic.

But what people do won’t change what businesses (i.e., advertisers) do. They’ll spend less on advertising, which means less revenue for Facebook.

If you have any lingering doubt about whether “new internet” companies can overcome old business realities, look no further than Alphabet Inc. (GOOG).

Google This

Google has long reigned supreme over the online advertising world. Like Facebook, its product (online search) is not its business (advertising).

And guess what happened when the company endured its first recession?

Countless pundits were convinced the company would be sheltered from the downturn.

In fact, at the time, one Bloomberg headline read, “Why Online Ads Are Weathering the Recession: In most media, 2009 will bring unkind cuts and Madison Avenue will never be the same. But internet advertising seems to be holding up.”

They were dead wrong!

Online advertising spending started to dip in the second quarter of 2008, before suffering a dramatic drop in early 2009. And sure enough, Google saw its share price suffer.

When all was said and done, shares dropped more than 60% from the beginning of the recession in December 2007.

Again, don't be fooled into believing Facebook will be spared a similar fate. Instead, be on the lookout for the first signs of another recession.

It’ll be your cue to start selling Facebook short. And it’s coming sooner than later.

How can I be so sure? Well, since World War II, the U.S. has entered a recession roughly every four years.

The two longest intervals between recessions were 10 years (March 1991 to March 2001) and 10 years and 8 months (June 2009 to February 2020).

But if we take out the two-month Covid-19 recession, which was an anomaly because the entire world was forced to shut down, it’s been 12 years and four months since the last normal recession.

In other words, we’re long overdue for a recession.

Of course, just because we’re “overdue” doesn’t mean a recession will magically materialize. It won’t.

But when it does materialize, now you’ll know precisely what to do:

Aggressively sell Facebook short.

Ahead of the tape,
Lou Basenese
Lou Basenese

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