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It’s Time for Investors to Start Unfriending Facebook Stock

Overbought technicals and rich valuations point to a looming pulllback in FB as momentum wanes

Shares of Facebook (NASDAQ:FB) are nearing all-time highs after a major rally. Facebook stock has moved higher by over 20% off its early October lows near $175. Much of this is on the back of the overall market’s move higher. The FB rally is starting to stall, however.

3 Things You Can’t Help but like About Facebook Stock
Source: Wachiwit / Shutterstock.com

Facebook stock is likely poised for a pullback over the coming weeks.

Facebook is fast approaching a price-to-earnings ratio of 34 and near the highest levels of the past year. The last time it was at such a rich valuation was last July which marked a multi-month high in Facebook stock. Any further multiple expansion will be difficult at best — a decided headwind for the rally.

Facebook reports earnings on Jan. 29. Consensus estimates are for $2.53 in earnings on $20.9 billion in revenue. It is interesting to note that Facebook has missed badly in two of the past four quarters, yet the stock is appreciably higher since that time. Combined expectations were for $7.64 in earnings while actual reported earnings came in at just $6.26.

Normally this magnitude of a miss would lead to a sharp selloff in the stock. Instead, Facebook stock has moved appreciably higher. How long can the momentum last without supporting fundamentals is the big question. At some point earnings will start to matter, even in this easy money driven market. My guess is we are nearing that point.

Facebook Stock’s Technical Chart

Source: The thinkorswim® platform from TD Ameritrade.

FB stock is looking tired from a technical take. The nine-day relative strength index is back above 70 and at levels that have marked significant short-term tops over the past year. Momentum reached an extreme and is finally headed lower. Facebook stock is trading at a big premium to the 100-day moving average which has signaled a pullback in the past. Shares are also well above the uptrend line which is yet another sign of over-exuberance.

Most importantly, Facebook stock had a doji pattern yesterday. FB opened and closed at virtually the same price on the day. This can be a warning sign that the trend has peaked. It is especially true after a long uptrend such as the most recent one in Facebook stock.

Stock traders should look to short Facebook stock on any further strength. An initial downside profit objective would be a return to the trend line near $204. The ultimate objective is a move back to the 100-day moving average at the $192 area. A meaningful break out to new all-time highs past the $218.62 level makes for a viable stop-out point.

Option traders may want to take advantage of heightened implied volatility in front of earnings and sell an out-of-the money bear call spread. The Feb $230/$235 call spread is priced near $1.00. Maximum gain would be $100 per spread with maximum risk of $400 per spread. Return on risk equates to 25%. The short $235 strike price sits well above the all-time highs for Facebook stock. It also provides a 10% upside cushion to the $213.06 closing price for Facebook stock.

As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a free trial of the Delta Desk Research Report can email Tim at timbiggam@gmail.com. 


Article printed from InvestorPlace Media, https://investorplace.com/2020/01/time-for-investors-unfriend-facebook-stock/.

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