Why the Drop in Social Media Stocks Looks Like an Overreaction

Users on their phones
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Shortly after the market closed yesterday, owners of social media stocks, of which I am a member, had a bit of a shock. Snap (SNAP), the parent company of Snapchat, released their third quarter earnings, and the reaction wasn’t pretty. They actually beat expectations for EPS, but a miss on revenue and the reason for it caused that stock to drop around thirty percent immediately following the release and dragged stocks like Facebook (FB) and Twitter (TWTR) with it.

The broad-based reaction was presumably because, in accompanying remarks, Snap CEO Evan Spiegel said that the changes to Apple's (AAPL) privacy settings for the iPhone had affected the company more than expected. Those settings ask users permission for apps to track them, reducing the ability of social media companies to target ads based on users’ likes and dislikes. Obviously, that is a negative for companies dependent on ad revenue, but even so, the reaction in the stocks looks overdone.

Over the last few years, social media companies have become used to overcoming challenges. They have been attacked by both sides of the political spectrum, for example. The Right seems to hate them for a perceived bias, although they routinely see anything that isn’t biased in their favor as biased against them, and the Left hates them because they allow far Right groups free access, so basically for the same reason. To me, being accused of bias by both sides of the political divide is a clear sign that they are doing something right but, from a business perspective, it is obviously a potential problem.

That, though, has been the case for some time, and is why the changes made by Apple were necessary and are probably the least bad solution for Snap, et al. It is a case of self-regulation of sorts by the private sector, which reduces the chances of far more burdensome government regulations. At the very least, it will prepare the companies for when that time comes and allow them to tweak their business models to fit the new reality, whatever that looks like.

All of this, of course, assumes that the revenue miss and reduced guidance for next quarter were entirely because of the changes to Apple’s policies, but that isn’t the case. In those same remarks, Spiegel also pointed out that the much-publicized supply chain issues and shortages had reduced advertising revenue. That may, in fact, be the bigger issue right now: If a company can’t keep up with current demand, why would they spend ad money trying to increase future demand?

Supply chain issues are problems that are inherently short lived. Free, or almost free, markets overcome them all of the time, and they will this time as well. When they do, advertising will be back in vogue, and the enormous reach of ads on social media sites, targeted or not, will again be a powerful force.

There is good news in Snap’s earnings report too. The fact that they beat on EPS despite the miss on revenue points to more efficient operations, and they grew users by an impressive 23% over the same quarter last year. As Spiegel said in his comments, "the growth of our audience, the adoption of our new products and platforms by our community, and the underlying efficacy of our advertising products for performance advertisers gives us confidence in the future of our business."

That is the important thing, and it applies in varying degrees to all social media stocks. A selloff as a result of the effects of iPhone privacy changes becomes visible is understandable, but it doesn’t change the fact that social media companies are powerful media for advertising and will remain so for some time. SNAP, TWTR, and FB have all bounced off their initial lows this morning and, while there will no doubt be some choppy trading over the next few days, long-term holders of the stocks should see the initial massive declines as an overreaction and hold tight for now.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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