An Emotional Market: A Case Study

As of this writing, Meta Platforms Inc. closed the day at a share price of $262.52, clocking a blistering 117% gain over the year to date. If we were to look back and reflect on past narratives, the sentiment was entirely different. Shares traded as low as $89, having fallen nearly seventy-six percent from their all-time highs. So, what happened to account for a company suddenly being undervalued by $435b relative to today’s pricing? What macroeconomic meltdown happened to cause the world’s leading social media conglomerate, and one of the largest companies ever, to plunge from its all-time high?

Like all public companies large and small, Meta Platforms Inc. is subject to the emotions and opinions of Wall Street that seemingly change on an hourly basis. In order to be astute long-term investors, it is imperative that emotional reflexes are overridden. This is easier said than done. While this example’s fall from grace and pending rebound are rare in terms of size and scale, it is a common occurrence in the world of investing for last year’s “golden child” to suddenly be on the other side of the coin.

When CEO Mark Zuckerberg started touting the metaverse, investors large and small grew concerned as this was a stark change of course for the company. The company was taking on the challenge of pioneering a technology that had never existed before and was significantly different from the company’s current cash-generating infrastructure. Negative headlines began appearing which claimed billions of losses were being accrued annually on the metaverse, with no profitable future in sight. The company’s stock price, which reached a high of $380 in September 2021, cratered down to its low by October 2022, merely thirteen months later. While the company’s financial performance indeed faired worse due to increased capital expenditures on the metaverse project, a devaluation of this magnitude within this timeframe would suggest the company was in a total meltdown. The narrative surrounding the company was far from reality. While a large number of factors were at play, psychological biases such as herd mentality and confirmation bias contributed significantly to these events.

Herd mentality is the tendency of individuals to behave in the same manner as the crowd. If a herd of sheep is all traveling in the same direction, the individual sheep bringing up the rear should follow. This way of thinking contributed to increased survival thousands of years ago and was successful at mitigating risks, therefore the thought pattern remained and grew with society. Within investing, this once useful heuristic can lead to the chasing of overpriced companies as they rocket up in value, or the panicked selling of otherwise decent companies with profitable outlooks.

Compounding on this, herd mentality in turn feeds toward another hurdle within investor psychology, that being confirmation bias. Confirmation bias is looking for facts or media that confirm previously held beliefs about a person, topic, or company. Following the crowd into a company allows for exposure to momentum appreciation, which can bring substantial gains. Seeing positive news articles on a regular basis about the latest hot company is euphoric for any shareholder and entices us to hold onto overvalued investments. However, when the tide turns, those glamorous articles fade away almost undetected, and it is difficult from a psychological perspective to change one’s previously long-held opinion. As non-professional investors hold out hope waiting for another rebound in share price, they are often left holding the bag.

In regards to Meta Platforms Inc, herd mentality contributed significantly as crowds piled out of the stock. Almost overnight, when the company announced its metaverse ambitions, Wall Street seemingly became united on the idea that the ride was over. Nearly every news outlet was falling over themselves to publish about its looming demise. As the stock price started to fall due to fear of the company’s future, confirmation bias started to take effect. Dozens of negative news headlines reported that the company was in dire shape, with the share price falling as much as 26% in a single day (Feb 3, 2022). With both of these events occurring simultaneously, it created the perfect storm for the share price to continue crashing far below its intrinsic value.

Recognizing that psychological biases such as these exist and that no human is immune is an imperative endeavor to tackle in order to be successful. Investing should be done in the absence of emotion. A grounding question to ask oneself when evaluating the impact of a glaring headline is, “How will this impact the company in 5 years?” Only naturally to be followed by, “Is the valuation of this company being supported by business fundamentals or fans?” In a world of instantaneous information and news stories that can influence billions in capital allocation in mere minutes, it is more important than ever to maintain a keen eye for when the crowd is getting lost. Human psychology and emotion erode investing returns when left unchecked. Being in control of the various mental forces that influence investing decisions will sharpen any investor, and likely enhance long-term returns.

As always, it is our blessing to serve you. We routinely look forward to growing together.

Warmly,

Zach Terpstra

Principal