Momentum is a powerful thing. You either have it, or you don’t.
This is what drives many of the highflying stocks, momentum. A clear example of a stock that has gone through a roller coaster is Facebook Inc. (NASDAQ: FB).
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When the stock first came out last summer, there was so much hype that it drove shares massively higher on the first day. Then the optimism swung to massive pessimism, and the shares essentially collapsed over the subsequent four months, hitting a low of $17.55 in September 2012.
At that point, all of the fast money was out of the stock, leaving longer-term investors the opportunity to accumulate shares. One thing you have to remember when it comes to investing, know who the shareholders are.
Part of this can be seen through the charts, part of this comes from due diligence by looking at who the shareholders are. When volatility picks up, and the speed of the stock (both up and down) accelerates, this is a sign that short-term traders are active in the name. Longer-term investors take larger shares of stock, and can be seen through regulatory filings, such as a schedule 13D filed with the Securities and Exchange Commission (SEC).
The reason why this is important is to help one determine whether or not to buy a stock. Valuation is extremely important, but only if the investors that are interested in the stock also use this same evaluation method that you do.
For example, if a company is trading at an attractive valuation, meaning it’s a value stock with a very low price-to-book ratio or free cash flow valuation, that factor will only have a significance if value investors are also active in the stock. They will also recognize the attractive valuation and accumulate more shares. Momentum and growth investors look at other factors.
Is Facebook a value stock? I think you’d be hard pressed to find any value investors interested in a $100 billion dollar company trading at a price earnings ratio of over 187 times, a forward price-earnings ratio of 43 and a price-to-book value of almost 8 times.
However, growth investors would be interested in the name, and they are the ones driving the momentum. With the stock continuing to soar on expectations of revenue growth in excess of 50%, the company’s ability to generate ad revenue on mobile devices is the catalyst.
When it comes to growth stocks, investors want to see a catalyst. If there is no catalyst, a stock might remain range bound for a very long period of time. However, when we see a catalyst, such as Facebook’s statement that its revenue generated from mobile devices is growing extremely quickly, this drives investors into a frenzy which they want to participate in.
The real question, if you’re not a current shareholder, should you buy this point?
Our analysis leads us to believe that the upside is quite marginal at this point. The company basically needs to increase revenue at least 45% year-over-year, a very large amount for a company of this size, to justify its current valuation. Their strategy for increasing ad generated revenue remain questionable, as to how effective they will be over the long term.
Can the stock continuing higher? It could, as momentum is very difficult to stop. However, we do see limited upside and any hiccup or problem will lead to a tremendous amount of selling pressure. There are far too many questions and not enough answers at this point for us to recommend buying the stock. We would remain neutral and look for more attractive stocks to buy.
If you would like to know how we would create a trading strategy using companies like Facebook, then check out our Flagship Newsletter or the Aggressive Investor Newsletter. If you would like to know how we would create a trading strategy for ETF’s, then check out the ETF Total Return Newsletter.
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