Interactive Investor

Tech specialists ditch Facebook but Terry Smith keeps faith

6th April 2022 10:22

Sam Benstead from interactive investor

The star fund manager says the firm is cheap, while others argue growth is slowing.

Top investors are split on whether Facebook, now known as Meta Platforms, will bounce back after disappointing user growth this year and scepticism around its huge spending commitments to build an online world, known as a “metaverse.”

The social media giant’s shares are 40% lower than their peak last autumn after it reported a drop of 500,000 daily active users for Facebook in the final quarter of 2021, the first drop in its history. Investors are also worried that its pledge to spend $10 billion (£7.5 billion) a year on the metaverse will not succeed and its new “Reality Labs” division will struggle to ever be profitable.

However, the business is still enormously profitable. Generating $39.4 billion in earnings last year, which was 35% more than in 2020, shares now trade on a price-to-earnings ratio of just 16. This is cheaper than the US market and half the price of Microsoft.

While user growth is slowing, it still counts on 2.82 billion daily active users in its family of apps: Facebook, WhatsApp and Instagram.

What the pros think about Facebook

Terry Smith, manager of the giant £25.8 billion Fundsmith Equity fund, continues to back the firm. Although no longer a top 10 position in the strategy, he has not cut his position.

Speaking to investors in March, he said its cheap p/e ratio made it undervalued and worth owning. Julian Robins, Fundsmith’s head of research, added that its shift to building an online world known as the “metaverse” was less weird and speculative than most people today think.

He said: “In five or 10 years’ time we will look back and laugh that we thought the metaverse was weird. We will all be living in it then.”

But other investors are selling shares. JPMorgan American (LSE:JAM) investment trust managers Timothy Parton and Jonathan Simon have sold their Facebook investment.

They said: “The company is the subject of intensifying negative publicity related to its invasive data policies and its unwillingness to stop the spread of misinformation on its platform. These claims are attracting mounting scrutiny from regulators and politicians.

“Despite posting better-than-expected earnings, the stock began to decline as third-quarter revenue undershot estimates, and the company became embroiled in further controversy generated by a whistle-blower's allegations about its business practices.”

Stephen Yiu, manager of the £960 million Blue Whale Growth fund sold out of its Meta investment before shares plummeted in February, citing concerns that its metaverse ambitions will not bear fruit despite all the money it is investing in it.

Instead of trying to pick the winning ecosystem, Yiu is backing the companies that will power them all, such as chip designer Nvidia and semiconductor manufacturing firm ASML.

Polar Capital Technology Trust, managed by Ben Rogoff, has also been selling shares. It is no longer in the top 10 holdings, the only one of the big five US tech stocks (Meta, Microsoft, Apple, Amazon and Alphabet (NASDAQ:GOOGL)) not to be.

Rogoff said: “Reels, Facebook’s short-form video product, is currently the fastest-growing content format on the platform but higher engagement on Reels will be cannibalistic to higher-monetising surfaces such as Newsfeed and Stories.

“Our concern is while Meta stock looks good value, there may be a further risk to earnings if the competitive threat from TikTok and Snapchat worsens. Fortunately, Snap (NYSE:SNAP) reported a much better quarter which allayed fears that these were industry-wide issues, so we reduced our Meta position and used the proceeds to increase our Snapchat investment.”

In January 2022, PCT had a 3.85% position in Meta, but that is now below 1.7% as it is not in the top 10 holdings.

Allianz Technology Trust, a rival technology fund, had just a 1% position in Meta at the end of last year, which is also well below its benchmark index level of 3.5%.

Smith bought Facebook shares on the cheap

Smith invested in Facebook in 2018 following the Cambridge Analytica scandal that saw its share price drop about 40% from peak to trough that year.

Smith, at the time said: “Our Facebook holding has cost us some performance to date and no doubt it will continue to be a difficult stock to hold in terms of media attention, but we have often found that the only time you can hope to buy stock in great businesses at a cheap valuation is when they have a glitch.”

He stressed how good the business was, saying: “In 2017, Facebook had a return on capital of 30%, gross margins of 87% and operating profit margins of 50%. Its revenue growth rate has averaged 49% a year for the past five years and over the same period operating profits have grown by 106% a year.”

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