What a difference a day makes.
Before the big drop in Facebook’s FB, +0.82% stock in extended trading Wednesday, I was receiving criticism for not raising The Arora Report’s “buy” zone. Now that Facebook’s stock has fallen on reduced revenue guidance and higher costs, here is the most often asked question: “How low will Facebook stock go?” Let us examine that with the help of a chart.
ChartPlease click here for the annotated chart of Facebook. Please note the following from the chart:
• The chart shows the overshoot in Facebook’s stock price.
• The chart shows The Arora Report’s “buy” zone prior to the decline.
• The chart shows the mirror image of the overshoot. In my 30-plus years of experience in the markets, I have frequently observed that when there is a big drop in a stock for fundamental reasons, the mirror image of the prior overshoot often provides a good estimate of how low the stock typically goes.
• The chart shows the major support. Often the major support acts as a magnet, especially if the overall market also starts correcting.
• The flip side of the price overshoot that Facebook recently experienced is an undershoot. Undershoots are fairly common but less likely in this case, because the fundamental valuation of Facebook is attractive. The chart shows the possible undershoot level.
• The relative strength index (RSI) is not yet oversold.
• The Arora Report is “long” Facebook from $49.92. When The Arora Report went bullish on Facebook, there was a lot of criticism. At one time U.S. News & World Report effectively urged its readers to not subscribe to The Arora Report because of its bullishness on Facebook. Not only did The Arora Report stay bullish on Facebook throughout the rise, it was the first to raise the target on Facebook above $200.
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Quantitative screenThe quantitative screen of the ZYX Change Method puts the fair value of Facebook at $161.
SentimentIn the near term, no amount of fundamental or quantitative analysis is going to matter. Facebook’s stock is going to trade on sentiment. As of this writing, the sentiment on the stock is bullish. The sentiment is especially bullish among the momo (momentum) crowd that has been buying this stock hand over fist. The momo crowd is seeing this dip as a gift to buy the stock at a lower price.
Money flowsSegmented money flows is one of those rare tools that gives investors a true edge. But it’s too early to make any conclusions from the data. We will keep you updated as the data become meaningful. Of special interest are smart-money flows, those of professional investors.
The very long termVery long-term fundamentals just got better than before the dip in the stock. Here are the main reasons.
The moves that Facebook is making are likely to successful head off regulatory challenges. This is increasing costs in the short term and hitting the stock, but is very bullish for the long term.
As Facebook makes new investments, it will become even more attractive to advertisers than it is today.
Some of the moves Facebook is making now will ultimately increase the profitability of Instagram, WhatsApp and Messenger. There is a long runway ahead to monetize those assets.
In the very long term, Facebook stock could go to over $300.
Early warningThe day before Facebook’s drop, the Nasdaq 100 ETF QQQ, -0.07% of which Facebook and other Big Tech stocks are members, had reversed itself. In our Morning Capsule, we gave an early warning to investors; our headline was: “Pay attention to the reversal in this index dominated by popular stocks.” Please see this updated version of the earlier post: “This reversal shows there’s risk in the bullish stock market — and Facebook is further proof.”
What to do nowFrom the information I am receiving, the big problem many investors are facing is that they did not position size their Facebook holding correctly. To be consistently successful in the long term through both bull and bear markets, investors need to learn to properly size their positions and construct their portfolios.
We often start a trade-around position around a very long-term core position. This technique often doubles the returns and lowers the risk. We will have to wait for our system to give a signal for starting a trade-around position.
We are temporarily suspending our “buy” zone for those not in the stock, but it will be reinstated soon as more data become available. The “buy now” rating on Facebook is also being temporarily suspended but will be reinstated soon.
Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.
