Facebook’s (Nasdaq: FB) shares got absolutely obliterated last Thursday, losing nearly 20% of their value after the company released a slightly less-than-stellar earnings report.
That amounts to a loss of about $120 billion.
To put that in perspective, that’s roughly the size of McDonalds’ (NYSE: MCD) market cap.
In other words, it’s as if a company the size of McDonalds evaporated due to one disappointing earnings release.
I say “slightly less-than-stellar earnings report” because the company managed to grow revenues by 42%.
Most companies would kill for that level of top-line growth.
But Wall Street had hoped for more, and the company’s guidance for future quarters wasn’t great.
With 2.5 billion people worldwide using at least one of Facebook’s products, this growth machine may finally be slowing down.
I should point out that that the 20% haircut to Facebook’s market cap merely erased the stock’s gains for 2018.
Had you bought the stock a year ago, you’d still be in the black.
And had you bought it at its 2012 initial public offering, you’d be up well over 300%.
The way this market has been behaving of late, Facebook may very well recoup its losses in a week and push to new highs. Stranger things have happened.
I personally have no opinion on where Facebook’s stock goes from here.
I refuse to own it in my personal account because, frankly, I’d just feel dirty.
Facebook and Instagram are more addictive than cigarettes and arguably more harmful. If I could ban the service and throw its executives in Turkish prison for life, I would.
But that’s neither here nor there. I mention Facebook to make some bigger points on investing in general.
So, in no particular order, here are a few takeaways from the recent plunge in Facebook’s share price:
Takeaway No. 1: Never Put All Your Eggs in One Basket
No matter how much of a “sure thing” a stock appears to be, over-allocating creates unnecessary risk.
Just ask investors tied up in banking stocks in 2008. The same goes for BP’s (NYSE: BP) shareholders following the energy giant’s catastrophic oil spill in 2010.
There’s no “magic number,” of course, but I try to limit each position to between 3% and 5% of my total portfolio in most of my trading.
In my most aggressive strategy, Peak Profits, I allocate 10% to each of our 10 positions.
Let’s say that one of my 10 stocks in that strategy had a Facebook-sized decline. My total portfolio loss would be 20% of 10%, or 2%.
I don’t like losing a single nickel, but a 2% portfolio loss is one that can be easily recovered.
Takeaway No. 2: Be Wary of Crowded Trades
It seems that the FAANG stocks – Facebook, Amazon (Nasdaq: AMZN), Apple (Nasdaq: AAPL), Netflix (Nasdaq: NFLX), and Google (Alphabet) (Nasdaq: GOOG) – have been the only game in town over the past few years.
Moves in these large-cap tech stocks can have a disproportionate effect on the overall market.
Collectively, the FAANGs make up about 11% of the S&P 500.
Meanwhile, tech’s weighting in the index has reached its highest levels since the 1990s dot-com bubble.
Historically, these imbalances have set the stage for sectors to underperform in coming years.
It happened to tech stocks in the early 2000s, to banking stocks after 2008, and to energy stocks over the past few years.
There’s no guarantee that tech underperforms from here, of course. But valuations are stretched, and expectations are high. That’s a bad combination.
Takeaway No. 3: Don’t Drink the Kool-Aid
Above all, you need to keep a level head.
It good to be excited by a company’s prospects. But don’t get cultish about it.
Tesla (Nasdaq: TSLA) is a good example.
I like Elon Musk. I’d love to have a beer with the guy and just pick his brain for a few hours.
The man is a visionary, and I hope the world of the future looks like his vision.
But no matter how amazing I think Tesla’s cars are – or no matter how much I’d like to drive one – I ‘m not going to run out and buy the stock.
The company hemorrhages cash and has no reasonable path to profitability.
Peter Lynch, the legendary manager of the Fidelity Magellan fund, popularized the idea of “buying what you know,” or buying the stocks of companies whose products or services you use personally.
If taken out of context, this can be truly horrendous advice.
Lynch never suggested buying a stock because you like or use the product.
He simply suggested using names familiar to your daily life as a starting point for more research.
So, trendy tech stocks may – or may not – be good investments. It’s up to you to crunch the numbers and make a judgment call.
Alternatively, you can take the guesswork out of investing by using a screener like I do in Peak Profits.
My proprietary algorithm rates stocks based on an assortment of value and momentum factors and selects only the 10 highest-ranking stocks.