Facebook’s Stock May Drop 8% Following Results Amid Higher Costs

Facebook Inc.’s (FB) stock has had a monster 2019 soaring by over 43%, more than double the pace of the S&P 500’s gain of 20.2%. However, the strong move higher may be about to come to an end following the company’s third quarter results. Options traders appear to be betting that Facebook’s stock falls in the weeks following the company’s earnings report, while the technical chart shows that the equity may fall by as much as 8.2%.

The company will report results on Wednesday, October 30 at the end of the trading day. Analysts estimate that earnings in the third quarter rose by 5.6% to $1.86 per share, on revenue growth of 26.4% to $17.35 billion. The company has seen rising costs in recent quarters as it invests heavily in user privacy and security, resulting in weaker margins.

Charts Point to Lower Prices

The technical chart shows that the stock has fallen below a key uptrend that had been in place since the December lows. Additionally, the stock has risen back to that uptrend, but failed to reclaim it, a sign that the uptrend is now acting as a level of resistance. Also, there is another level of strong resistance around $190. The two layers of sturdy technical resistance will make it challenging for the stock to rise. It would suggest that the stock is likely to drop to a level of technical support at approximately $173, a decline of about 8.2% from its price of $188.50 on October 25.

Meanwhile, the relative strength index is also trending lower. The downward sloping trend line comes during a time that the stock has been trading sideways. This pattern is known as a bearish divergence and suggests that bullish momentum is leaving the stock and shares are likely to fall.

If the stock should rise above resistance around $190, it is likely to rise back about $205.

Bets Suggesting Shares Fall

The options market suggests that the stock rises or falls by about 7.5% from the $185 strike price by the expiration date on November 15, using the long straddle options strategy. It would place the stock in a trading range of $171.25 to $198.75. The calls do outweigh the puts at this strike price, with 28,500 open call contracts to just 22,000 open put contracts.

On the surface it would appear that there are more bets for the stock to rise. However, when digging into activity using data provided by Trade Alert, we can see that on October 18 10,000 of those call contracts were traded on the bid, a sign that those calls were sold. It indicates a bet that the stock is trading below $185 by the expiration date. Additionally, the data also shows that on October 18 10,000 put contracts traded on the ask, a sign that the puts were bought, and a bet that the stock will fall.

It’s About the Margins

Facebook has a history of crushing analyst earnings estimates. Over the past eight quarters the company has easily been able to beat analyst estimates each time. Additionally, the company has topped analysts’ revenue six of those last eight times. Reporting results that come in better than expectations are likely not to be Facebook’s problem this time around.

What is likely to be Facebook’s problem is its margins. Over the past few quarters operating margins have seen a dramatic decline falling from the mid-40% region to the mid-20%. Those lower margins are the key reason why analysts project revenue to climb by almost 26% in 2019 and 22% in 2020, while earnings are expected to grow by just 7.3% and 14.2%, respectively.

If the company can get its cost under control and show investors the heavy spending is behind it, then the stock is likely to rise sharply in response. But if the operating costs stay high and margins remain under pressure shares are likely to continue to struggle. It may be one reason why the chart and options are suggesting the stock falls in the days and weeks following results.

Michael Kramer is a financial market strategist and the portfolio manager of the Mott Capital Thematic Growth Portfolio.

Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future results.