Was Facebook's Stock Price Face-Plant Justified?

In this episode of MarketFoolery, host Chris Hill is joined by Maria Gallagher of Motley Fool Asset Management and summer investing analyst Troy Springer to chat about some of the more interesting headlines on Wall Street -- and there's no question that anyone's rundown would start with Facebook (META 0.43%). Shares fell through the floor recently on word that the revenue growth rate was slowing significantly, and would continue to do so in the quarters ahead.

Next, they turn their attention to another region of the online universe, where Spotify Technology (SPOT 0.20%) came in with a set of second-quarter numbers that featured the sort of growth that Facebook lacked. Just one problem: Spotify is still missing one key ingredient that Facebook has in abundance. And finally, Chris thinks a bit outside the box: Usually, the "stocks on our radar" segment is reserved for Motley Fool Money, but he's querying his MarketFoolery guests this time, too, giving Maria an opportunity to explain why she foresees better days for General Mills (GIS -0.77%), and Troy one to talk about why he's bullish on recently public apparel industry disruptor Stitch Fix (SFIX 0.47%).

Maria Gallagher is an employee of Motley Fool Asset Management, a separate, sister company of The Motley Fool, LLC. The views of Maria Gallagher and Motley Fool Asset Management are not the views of The Motley Fool, LLC and should not be taken as such.

A full transcript follows the video.

This video was recorded on July 26, 2018.

Chris Hill: It's Thursday, July 26th. Welcome to Market Foolery! I'm Chris Hill. Joining me in studio, Troy Springer and, from Motley Fool Asset Management, Maria Gallagher. Thanks for being here!

Maria Gallagher: Thanks for having us!

Troy Springer: Of course!

Hill: We have Spotify, we have a couple of stocks on our radar, but our lead story today, and when I think about it, it's probably going to be the lead story on Motley Fool Money this weekend, it's of course, Facebook. Wow! Second quarter profits came in slightly higher than Wall Street was expecting. Troy, Wall Street could not have cared less about the profits, because Facebook's CFO on the conference call painted an incredibly clear picture of revenue for Facebook, and it's going down.

Springer: Right, by high single-digits, going down about 8-9%. To put this in perspective, Facebook was down about four Twitters (TWTR) after hours yesterday, falling about 20%. One thing I'd say about the revenue growth, 8 or 9% may sound like a lot for a normal company, but this is a company that grows revenue year over year at 40-50% every year. So, it might not be as scary as it sounds. 

The main problem with their revenue growth is, they're unsure how to monetize the new Stories business. Snapchat has been in a similar boat trying to figure out a way to monetize Stories. Instagram's Stories has been a huge success. Because of that, Facebook tried to take Stories over to the Facebook platform as well as the WhatsApp platform.

On the conference call, when an analyst asked Sheryl Sandberg about monetization of these Stories going forward, she basically said, "We don't really know right now, and that's why we're revising guidance down."

Hill: Yes, there's that. Let's be clear, Mark Zuckerberg told us this was coming. We've know, Maria. He's been very clear about the fact, like, "We're going to be spending more money on security, we're going to be hiring more on security." But, again, when you have the CFO saying, "Revenue, high single digits lower than it was the previous quarter, and this is going to happen again next quarter. We're going to take another step down in high single digits, and the quarter after that."

Gallagher: I think, though, that it's a strategic move for their future. While, on the conference call, he was talking about their investment in people and AI and how that's going to increase security, and how they've created this portfolio of all of the ads they have and who pays for them. I think their increased transparency in their apps is what's costing them a lot of money, and their AI in that is costing them a lot of money. But I think, to regain their name and the trust of the people who use Facebook, this is strategic choice for them for the future. I think that's really smart.

Springer: I don't think Mark Zuckerberg has ever cared about what analysts thought in the short-term. He actually sounded very Foolish on the conference call, saying, "We run this company for the long-term, not for next quarter." He opened up the call saying this was a solid quarter for Facebook. One thing I might add --

Hill: Can I just say that pretty much every investor today disagrees with that? I agree with you, he's very focused on a long-term. The stock is down about 18% today.

Springer: Right. What I will say about the stock, since the Cambridge Analytica scandal, it's been up 40%. This 20% drawdown doesn't look as bad in context, knowing that Facebook has been up 40% since then. I think a lot of times, as investors, we like to make a big deal about big one-day drop, because it's a visible number to look at. But in the grand scheme of things, Facebook has been doing well. I think they're a great platform with 2.2 billion users, and it's a safe investment going forward.

Gallagher: I agree. Archive was the word I was looking for, an archive of their ads. I also think, something to note that nobody asked about that I thought was interesting was, their average price for ads is up 17%. With this deceleration, I wonder if they're going to start charging more for ads. I think with their rhetoric around being helpful to small businesses, if this is going to be something that drives small businesses away, because they just can't afford to have ads on Facebook anymore like they used to. I thought that was an interesting statistic to bring up. No one asked about it in the questions part of the conference call, but I thought it was really interesting.

Hill: It'll be interesting to see, as you broaden the picture here and think about digital advertising dollars in general, if, in fact, they are not going to be flowing as readily toward Facebook, who stands to benefit from that? If you look at the stock performance of Twitter over the past year, that's worked out really well. I also feel like, if Snap (SNAP 27.63%) is ever going to do anything, right now is the time. If Snap can't make their bones in the next six months off of what's happening with Facebook right now, maybe it's time to pack up and go home.

Springer: I push back on that statement a little bit. A lot of people have said that Facebook's dip in revenue is Snap's and Twitter's space to gain, but I'd argue that Facebook, Instagram specifically, is such a powerful platform. Instagram is continuously leading Snapchat and out-innovating Snapchat, and especially Twitter. Their new Instagram TV is going to be more revolutionary than Instagram Stories. Video is a huge way that Facebook is going to continue to monetize their platform, both on Instagram and on Facebook.

Hill: Let's move on to Spotify. Second quarter revenue for Spotify came in 26% higher than a year ago. That's good, Maria. If you're looking at actual profitable dollars, keep looking. They're doing a couple of things right, probably. Don't you think? They're growing revenue, they're growing subscribers. But, anyone who's looking at Spotify and looking for profits, they're not going to find any.

Gallagher: Yeah, they're not profitable, they've never been profitable. It's important to note that their monthly average users is up 30%. Their premium subscribers is up 40%. But, like you said, they haven't been profitable. I think that draws more questions about the industry and less about the company. It's a strong company, but the streaming service industry is so young. Also, they're paying so much in royalties. Spotify only gets 30% of the money, and 70% goes back to the labels for royalty. That begs the question of, how profitable is this industry, less the question of, how profitable is Spotify.

Hill: The fact that shares of Spotify are up 3-4% today, where do you think that optimism is coming from? Is it just the growth, the feeling that, look, they are growing their paid subscribers, they are boosting their overall revenue, so at some point, the profits are going to come?

Springer: The market has really paid a big premium to companies who command a lot of data, and that's what Spotify has. They have a lot of data on the users, what their preferences are. It's similar to the Netflix (NFLX -0.63%) argument. Netflix has more data, so they can provide a better experience. That's where Spotify is buttering their bread -- on their Discover Weekly playlists, and everything like that. I totally agree with Maria's point. The economics of this business, of the music industry in general, is not good, and it's never historically been good.

Hill: Not for the artists. Historically, the music business, not great for the artists.

Gallagher: No, not great.

Hill: Good for the record labels.

Springer: Right. I think it's a totally different industry than video, in the sense that Spotify has to pay royalties every time someone plays a song. That's a recurring cost that they're always going to have to pay. There's decreasing returns to scale. In a video business, Netflix can pay a whole bunch of money up front, and they don't care how many times people watch the video. They want people to watch the video more. So, I think it makes it really tough for Spotify. At the valuation they're at, it's a little speculative.

Gallagher: I agree. To build on that, like you said, the music industry has been profitable for labels. I don't know if you've heard the myth that Spotify is going to open a record label, but the CFO yesterday said that's not true and they're not planning to do that. But, I think that's an interesting way to see how that business would grow. Artists have been pretty vocal about disliking their labels. It's not like artists are super loyal to the labels that they are currently under. So, that would be an interesting thing. Even though Spotify says it's not going to start its own label, I wouldn't be so certain.

Hill: You have a Spotify account?

Gallagher: Yeah.

Hill: A premium account? You're paying for that?

Gallagher: Yeah. I started as student premium. This is also pretty indicative of how it usually works. I started paying for premium as a student, so it was cheaper. But once my student service was over, I really didn't want to have to listen to ads, because I was so used to not listening to ads, I have all my good playlists that I listen to at the gym, so I just pay up for premium.

Springer: It's the best $10 I spend a month.

Hill: [laughs] To go back to something you were saying, Troy, you brought up Netflix. We've talked in this studio before about video streaming services being, in some ways, complementary to one another. It's not like buying a car. You can have your Hulu account and your Amazon Prime account and your Netflix account. I don't think that's the case with this. It's basically, pick a music service. You have Spotify. In our house, we have Pandora.

Gallagher: You still use Pandora? [laughs] 

Hill: Yeah. You know why? I'll tell you why. I got it as a Christmas gift for my wife. I was like, "I'm going to get a premium account." And Pandora's gift experience was so smooth and so easy. I actually went to Spotify first. Spotify did not make it easy for me to buy a gift subscription. To the extent that anyone at Spotify is listening, you might want to work on that.

Gallagher: Can you name your playlists in Pandora? I think that's the most excited I get about Spotify, when I can come up with a new playlist name.

Hill: I don't actually use the account, I just got it for her, so I don't know. But, hey, that's a nice little thing. I guess, the larger point is, you're not getting a second music streaming service. No one is going to be like, "Well, I have my Spotify service, but I'm also going to pay for Apple Music."

Springer: No. There's not much differentiation in the industry, which makes it tough.

Gallagher: Yeah, unless you're Jay-Z and you have title, and you can't listen to Jay-Z anywhere else.

Springer: That's the argument for Spotify. Spotify gets so much leverage, to the point where even smaller artists like working with Spotify, and they can maybe skip the record label? That's really the huge opportunity for Spotify. But when there's not enough differentiation between them and Apple Music, it might be hard for Spotify to gain that much leverage, to actually cut out the middleman of the record labels.

Hill: Every week on Motley Fool Money, we have stocks on our radar. I wanted to bring that to Market Foolery with you. I'll start with you, Maria. What's a stock you've been looking at this summer?

Gallagher: I'm going to preface this by saying that consumer packaged goods companies haven't had the strongest run recently, and General Mills, who I'm going to talk about, isn't an exception. Their stock is down around 27% and they haven't had sales growth since 2013. But, this company has been around since 1928, and I think there's a reason behind that. 

I think it's an opportunity to buy it, because it's priced and treated in the market like a company that's in terminal decline. While their historically profitable moat of having this brand recognition is eroding, I don't think they're burying their head in the sand. I think their plans for future growth are positive. They're planning to expand their portfolio. They recently acquired a pet food company, they acquired a health food company. They're trying to grow into these more premium categories. They're repositioning their existing brands and driving their e-commerce growth with a goal of $1 billion in sales of e-commerce growth by 2020. 

I think it's currently undervalued compared to its peers. I don't think it's as dying as everyone thinks it is. It still has strong brand recognition, it has really strong plans for the future, and it's a company that's going to continue to do well.

Hill: I think you may have made a slight understatement when you said that the industry of packaged goods hasn't had a great run lately. Earlier this year on this podcast, I think I said something along the lines of, "This is now the single worst industry to try to invest into." It has replaced teen apparel as an awful industry to try to invest in. When you look at General Mills, it sounds like the case is almost entirely about valuation.

Gallagher: Yeah, definitely. I think they're a strong company. Right now, they're not being priced as a strong company. You're right, the industry isn't the best, but people always need to eat. I don't think the industry is going away. It's not going to become an industry that no one uses.

Hill: The pet food company that bought, Blue Buffalo?

Gallagher: Blue Buffalo, yeah, $8 billion.

Hill: Yeah, that was a stand-alone company, and there were a few people at this --

Springer: People spend on their pets.

Gallagher: They do.

Hill: They do. I remember, there were a few people, I think Jason Moser was one of them, Abi Malin was another, who were fans of that company and were disappointed when it got acquired.

Springer: I think it was a smart acquisition.

Hill: No, kudos to General Mills for the buy, it was more like, they were hoping they were going to stay independent. Troy, what have you been looking at?

Springer: I've been looking at Stitch Fix. Stitch Fix is a recent IPO in the past year. It's up 80% since it IPO-ed. Stitch Fix is another of those data-driven companies that's a pure play on disrupting retail. What they do is, you go online, fill out a survey of what your style is for men and women. They send you a box with four to five different clothing items in it. You try them on, choose which ones you want to wear. The things you want, you keep; the things you don't, you send back. If you buy all of them, you get a discount. Most boxes cost about $200. 

What got me really interested in Stitch Fix when I started looking at it is, at around the time of its IPO, it already had better operating margins than a company like Nordstrom. To me, if Stitch Fix was able to command better margins than a premium company like Nordstrom, that seemed pretty interesting. 

They also have a great CEO who's on the Glassdoor Top 100 CEO list, Katrina Lake, one of the forerunner female CEOs out there right now, graduate of Stanford and Harvard. I think this is a company that's really set up for the future. The data they're collecting on style is really valuable -- the fit, the wear. I've gotten three Stitch Fix boxes, and they're the best clothes I own.

Hill: Nice. Have you used them?

Gallagher: I filled out their online survey, and they picked out some really cute outfits for me --

Springer: Pull the trigger!

Gallagher: [laughs] I haven't pulled the trigger and actually subscribed.

Hill: I'm curious if they've always been for men and women, or they started more for women. The reason I ask that is because I've seen a lot more ads lately specifically for men. I'm just wondering, in the same way that a few years back, Lululemon identified men as a growth category for them, even though it's like, "Yeah, we have a few things for men, but ... " is that the case with Stitch Fix?

Springer: It started for women only, but since they've IPO-ed, they've had a men's line for a long time. I'd say, that's definitely a growth area for them. Men spend 80% of what women do, according to their research, which is a little closer than I thought. 

The other thing I'd say, at least for me, I don't like to shop. And I don't have great style, or really care to look in the magazines to figure it out. If I have someone telling me, "Troy, this is what's in style now," and they send it to me, I'm going to believe them. 

I think it's a big growth area for men. Their Stitch Fix Men Instagram account has about 70,000 followers. They're working with a lot of the male influencers on Instagram to spread their brand. But there's probably more competition on the men's side, between a lot of other box start-ups that send you stuff. But with the data that Stitch fix has, it's a superior product.

Hill: Alright. Troy Springer, Maria Gallagher, thanks for being here!

Springer: Of course, Chris, it was a blast!

Gallagher: Thanks for having us!

Hill: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed by Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you on Monday!