Facebook’s stock is likely to rally even further in coming weeks.
That’s just the opposite of what I wrote late last July, when Facebook’s FB, +0.57% stock had just plunged from an all-time high of $217 to $176. The shares eventually fell another $52, bottoming on Christmas Eve at $124.
That was a stunning five-month fall from grace for Facebook, a 43% plunge, in contrast to a 17.4% drop over the same period for the S&P 500 SPX, +0.07%
Since Christmas Eve, the company’s stock has rallied around $40. The reason to expect even more of a recovery is that Wall Street analysts are slow to react to developments. As those analysts gradually incorporate into their analyses what the market as a whole has been sensing lately, Facebook’s share price is likely to rise.
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The reason analysts are slow to react is that, by nature, they are conservative. Before fully updating their forecasts, they typically wait until the evidence points overwhelmingly towards a revision. This in part is because the noise-to-signal ratio is sky-high; it is unlikely that any particular piece of news has any meaning. But it’s also because analysts want to avoid the appearance of merely following the lead of the analyst community. So even when they do finally think a revision is warranted, they may wait if many other analysts have already revised theirs.
Michael Clement, an accounting professor at the University of Texas, Austin, has found that, for these and other reasons, the market tends to react more quickly than do Wall Street analysts themselves. To put it another way, most analysts are followers rather than leaders. In an email, he referred me to one academic study which found that analyst forecasts typically reflect just 66% of the information that the market itself has already taken into account.
This phenomenon is illustrated in the accompanying chart, which shows that analyst upgrades and downgrades tend to come in waves. As you can also see, the current wave is towards an increasing number of upgrades. As this upgrade wave continues, Facebook’s stock is likely to rally even more.
To be sure, the phenomenon of analyst underreaction doesn’t guarantee this happy outcome. It’s entirely possible that some piece of unambiguously bad news about Facebook will emerge, thereby ending the upgrade wave that is currently underway. But more often than not this does not happen.
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