Portfolio holdings Meta Platforms (FB) and Alphabet (GOOGL) — the parent companies of Facebook and Google, respectively — fell Tuesday after Snapchat (SNAP) shares cratered on a profit warning. The owner of Snapchat said late Monday that it will miss its revenue and adjusted earnings targets for the current quarter. All three companies rely heavily on digital advertising spending. FB and GOOGL dropped about 8% and 6%, respectively, during Tuesday’s session, in an already tough year for these stocks. 

What happened

Snap’s (SNAP) negative update Monday night obviously caught Wall Street’s attention, with shares plunging 40% and pacing for their worst-day ever. This comes after just a month after the company reported its quarterly earnings. Things have deteriorated so bad for the company in the past month that it has to pre-announce a bad upcoming quarter.

Advertising is a cyclical business tied to the strength of the economy. Investors were already wary that the economy may be slowing down and corporations could see lower-than-expected profits as a result. The earnings reports from Target (TGT) and Walmart (WMT) last week put their concerns front and center. Then came Snap’s pre-announcement. In a securities filing, Snap said the “macroeconomic environment has deteriorated further and faster than anticipated,” which in practice means advertisers are spending less on Snap’s platform and its revenue forecast from just over a month ago is going to be wrong. Competitive dynamics could have played into Snap’s shortfall as well, namely from TikTok.

Implications for FB, GOOGL

Meta gets most of its revenue from digital advertising on Facebook and Instagram, and so does Alphabet through Google Search and YouTube. That’s why investors in those stocks care about what Snap has to say. The question right now, essentially, is whether those two companies will experience the deterioration from the “macroeconomic environment” in similar magnitude to Snap.

Morgan Stanley analysts wrote Tuesday that they expect “all online ad platforms to feel some impact of a significant consumer pullback.” 

Analysts at KeyBanc Capital Markets offered a similar view in a note to clients Monday night. Here’s what they wrote:

"Given Snap is a low-single-digit percentage of industry ad revenue, we view the 2Q guidance update as a cautionary flag but not one to sound the alarm on the entire sector. ... We believe GOOGL and FB likely face lower risk to revenue and margins. Both companies are core to direct response advertising (i.e., last ad budgets to cut) and are disciplined with opex reductions (FB is already doing this) and buybacks. Between the two, we see more incremental risk to GOOGL margins as revenue mix shifts to lower margin, high investment areas (e.g., Cloud)."

Goldman Sachs analysts also noted Monday night that Snap’s results and management commentary “has historically been more volatile in nature compared to large cap names (such as FB and GOOGL) given their scale, level of platform maturity & size of its advertiser base (SNAP being exposed to a narrower set of advertisers.”

On a very basic level, Meta and Alphabet are just different companies than Snap. Meta and Alphabet are profitable. They return capital to shareholders through sizable buyback programs; Alphabet just announced a $70 billion share repurchase program last month. Those are the kinds of companies we want to be shareholders of in this difficult market.

Snap, in contrast, does not return capital to shareholders and generally loses money every quarter. In its fourth quarter of 2021, the company’s net income was surprisingly positive for the first time since the company went public in March of 2017. But then in the first quarter of 2022, net income was back in the red.

Meta and Alphabet trade at reasonable price-to-earnings ratios. On the other hand, investors have to value Snap on a price-to-sales basis, and those are the types of stocks to avoid in this environment. The Club has been preaching that since last year.

Bottom line

Put it all together, we would advise some nibbling or just holding steady with Meta and Alphabet, given their current valuations of 15.5 and 18.5 times forward earnings, respectively, and their historic growth rates.

Yes, there’s some potential near-term macro weakness ahead and more pain in the market. But we have a longer time horizon than the next quarter alone. Snap’s announcement alone doesn’t change our belief that we can ride it out with these formidable tech giants and come out the better when the storm clears on Wall Street.