An investment analysis on Facebook

Investment Horizon: 4-5 years

When the Cambridge Analytical crisis first shocked the Internet, it naturally piqued my interest on Facebook and I started to have the idea of conducting research on it. One of my motive of analysing Facebook as a company is to look for investment opportunity and another contributing factor is to sharpen and bulk up my investment acumen (For the past two years I’m spending much of my time and concentration on my studies and also learning fundamental knowledge about psychology, investing, finance and economics through various books). Since I’ve just finished my SAT test in May and have plenty of time while waiting for my first IB semester to commence, I decided to take a serious and holistic analysis on Facebook, spending my time on meaningful activities.

Throughout the process of conducting research on Facebook, I’ve met some obstacles that prevents me from getting data that I needed in order to arrive at a better and more sound conclusion, and also realise some of my weaknesses that hinder me from being better informed and make the best investment decision possible. Nevertheless, I give you my word that this piece of analysis is definitely well-conducted after hours of thinking and judgement. You are welcomed to give constructive feedbacks and speak up your opinions if you held a different view. As I’ve always believed, thoughtful disagreement is the path to understanding the truth better. I will address the shortcomings of the analysis and my weaknesses in the next post so that everyone get a chance to learn from it.

Before I start, I’ll note that this is a lengthy analysis and it may be boring to read for some of you. For those who want to save their time and jump straight to the conclusion, here’s it:

  1. Facebook Inc is a company with sound financials, competent management and solid fundamentals (although it has weakened compared to the totally dominant position it enjoyed few years ago)
  2. The current price (as of 6 July 2018) is slightly stretched and I believe that there will be better buying opportunity in the future 1-2 years due to potential economic headwinds 

With all these being said, I shall start my analysis now.


Concept Glossary

I may use some terms and concepts that some readers may not understand. Hence, I will try to clarify these ideas here so that it will be easier for you to grasp their meaning and understand my points better.

Gresham’s Law: Originally applied in Economics, it states that bad currency drives good currency out of the system. Here, I use this law to depict the scenario that bad players in an ecosystem drive good players out of it

Critical point: An extremely important juncture in a company/system which is critical to the operations and success of the company/system

Divine Discontent: A concept that I’ve learned from the thought-provoking blog by Ben Thompson, Stratechery, which states that consumers always have a voracious appetite for a better product, they will never be fully satisfied and stop pursuing a better product, thinking that ‘this is enough for me’. For more information about Divine Discontent, you can browse the article at Stratechery

Network Effect: Refers to a positive feedback loop, where positive developments in an area inadvertently leads to positive outcomes in another area and reinforce each other that results in a virtuous loop. It can also works conversely, where negative developments in an area inadvertently leads to negative outcomes in another area and reinforce each other that results in a vicious loop

Critical Mass: the amount of substance needed to force a chain reaction and alter the development of an ecosystem

Positioning 定位:  the place that a brand occupies in the mind of the customer and how it is distinguished from products from competitors.


Company Profile

I guess many of you are quite familiar with what Facebook is and what it does so I won’t go into details explaining what Facebook is here. But do you all wonder before that how does Facebook make money? The short answer is, advertisement (which makes up most of its revenue). In fact, Facebook Inc does not only consist if the Facebook app, it also comprises Instagram, WhatsApp, Messenger and Oculus VR. It made many acquisitions in these few years but most of them are of relatively small size and not likely to make a huge impact on the bottom line of the company,rather, more likely to act as complementary product or features to their main products. Therefore, Facebook, Instagram, Messenger, WhatsApp and Oculus VR are collectively known as the Facebook Family of Companies, as per Facebook Inc. The entire monetisation process of Facebook’s business consists of three critical links:

  1. Maintaining and growing their social media ecosystem
  2. Obtaining and utilising user data to get meaningful insights 
  3. Placing ads in the social media platform targeted on their user base

I’ll break down these three critical links one by one and explain my analysis on their dynamics and Facebook’s competitive position and performance on each of them.

Maintaining and growing their social media ecosystem

As we’ve all know, Facebook’s social media ecosystem consist of Facebook, Instagram, Messenger and WhatsApp. We shall start with Facebook, as it is the largest among all of them and the primary revenue source for Facebook Inc.

Facebook

I think everyone on Earth not living under rock should knows what is Facebook and what kind of services does it provide. In a sentence, Facebook is a social media platform which enables people to connect with their friends and families, and keep themselves updated with the lives of their “Facebook Friend”. I think many of you might have already realised that the way you and your friends are using Facebook has undergone a huge shift in the recent few years. In fact, the way people communicated and interacted on Facebook has changed dramatically. Why have all these changes taken place? Before I give out my point of view, let me introduce a few dynamics that are at play in the Facebook ecosystem:

Network Effect (as mentioned in Concept Glossary)
Divine Discontent (as mentioned in Concept Glossary)
Gresham’s Law (as mentioned in Concept Glossary)
Positioning 定位 (as mentioned in Concept Glossary)
Critical Mass (as mentioned in Concept Glossary)
Attention Pie

It  won’t be all surprising that there are more and more players coming out of the social network industry such as Twitter, Instagram (owned by Facebook), Snapchat, Musical.ly, Vine etc when you understand three fundamental concepts that shape the dynamics of social media industry: Divine Discontent, Gresham’s Law and the characteristics of the industry. To understand the consumer behaviour of social network users, we must understand that Divine Discontent is at play. Divine Discontent makes us understand that users will never fully satisfied and stay content with a one-size-fit-all app for interacting with their acquaintances. Instead, users will be eager to try out the ‘new thing’ out there for the sake of excitement,curiosity and novelty. What’s more is that, if the new app actually provides an exciting and original experience for users, they will adopt it very quickly. Once the users adopting the new social network app reached a critical mass, the app will soon establish a formidable regional network effect, reinforcing positive outcomes (more users lead to more users).

If Divine Discontent is absent is the social media industry, Facebook would’ve been the only social network platform that exist: People can type 140 characters in Facebook, yet they still use Twitter; people can upload pictures and videos on Facebook, yet they still use Instagram; teens can send selfies to their friends using Facebook Messenger, yet they still love Snapchat. 

Another important force that contributes to the fragmentation of social media apps is the characteristics of the social media sector: low switching cost, low loyalty, low stickiness. Creating a new account in a new social media app isn’t a painstaking and troublesome process: Fill in your email address, set your password. As simple as that and you have a new account now! People won’t have any second thoughts before trying out the hottest social media app because is is free, and most importantly, the existing app they are using is free too. No sunk-cost fallacy playing out here. That’s why once a new social media app can grab the attention of consumers in a short period of time and establish a regional network effect, it has the potential to grow into a formidable force that wakes up the social network behemoths at night. The golden goose lies in establishing a wide network effect. Low loyalty and low stickiness is the product of zero sunk-cost, zero opportunity cost and Divine Discontent.

The third law active in social media platforms is Gresham’s Law. Bad players drive good players in the ecosystem out. The bad players here have a slightly nuanced definition. ‘Bad players’ here refers to players whose existence will irritate a substantial group of users and nudge them to spend less and less time on the social media platform (thus triggering a reversed network effect and starting a vicious cycle if the critical mass is reached). Bad players, therefore, includes spam bots, excessive advertisements, fraudsters and also middle-aged parents and elderly. Middle-aged parents and elderly are considered as bad players because they are one of the catalysts that drive down the engagement time of teen users and millennials on Facebook. The large influx of middle-ages and elderly into Facebook prompt young users to feel that Facebook isn’t as ‘cool’ as it is before anymore and their actions,speeches and thoughts are not unrestricted as before. Facebook is no longer the place where they can say anything or post anything unfettered anymore. There are eyes watching on them now.

A large part due to the dynamics of Divine Discontent and Gresham’s Law, specialisation is an inevitable outcome in the sector (I apologise for yet another self-invented terminology here). Specialisation means that each social media app occupies a special place in the users’ mind for their different core functions, meaning that each app specialises in different scenarios and uses. To give you several examples here:

App: Instagram  Position: Following friend’s lives and uploading pictures
App: Snapchat   Position: Selfie-oriented messaging and uploading moments of real life
App: Twitter       Position: Following celebrities, viral trends and relevant topics

With these dynamics in mind, we have the tools needed to make sense out of the development of the Facebook ecosystem these few years. In their early days, Facebook was the active community for young users to express their thoughts and feelings. However, later on, the influx of middle-ages and elderly (bad players in this context) and the Divine Discontent dynamics at play gradually causes young users to spend lesser time on the social network and put more of their time on other social media apps such as Instagram and Snapchat. Middle-aged and elderly groups are a growing share of Facebook’s user’s demographic and the position of Facebook in the mind of teen users and millennials is growing weaker and weaker, as is it not the only social network that they are using anymore. Many more choices are in the market now. They are more willing to spend their time on Instagram and Snapchat relative to Facebook.

Although it’s good news that Facebook is encompassing more users from larger age groups, constantly declining interest of young age groups in Facebook is still a problem that can’t be ignored, as they still constitutes a large part of Facebook’s user base. To add insult to injury, the dynamics of network effect at play is also slowly reversing: when your friends post more thoughts and share more feelings on Facebook, you will naturally spend more time on Facebook engaging with them. If the activities of your intimate friends of Facebook decline, you will also naturally spend less time on Facebook, diverting the attention to the social networks where you friends are active on. To counter this situation, Facebook decided to channel their resources and attention to two elements that will, in their hope, rekindle the interest of younger age groups on Facebook and make Facebook an active community again as it once was.

The two elements are videos and news.

That’s why in the past two or three years, your news feed is flooded with news and interesting videos instead of your friends’ feelings and thoughts. There are two reasons that shape these changes. One of them is that users already rarely share their thoughts and feelings on Facebook anymore, another is Facebook’s effort to make a news-and-videos-oriented news feed, its goal is to attract users to spend more time on the platform consuming news and video content instead of engaging with friends in the old way. This is a huge gamble, and it works. Although injecting many news in their news feed algorithm does cost them a lot of problem and even harm its brand image (fake news scandal flooding everywhere), although younger age groups still spend more time engaging with friends on Snapchat and Instagram, and even though users don’t actively engage with each others and share their thoughts as active as they used to, Facebook manage to curb the declining interest of teens and millennials, and re-occupy its unique place in users’ mind, albeit by news-and-videos-oriented content. Facebook users engage on their platform, but in a more passive way, through video-sharing and news-sharing, and also tagging friends on content they find interesting. Furthermore, Facebook is growing its presence and market share in developing countries and Asia Pacific region, especially Indonesia and India. Later, Facebook also double its effort on Facebook Groups, emphasizing it more than ever. It succeeded in creating active local and regional groups on Facebook, building a strong and active regional-based group and interest-based group on its platform.

Facebook can never go back the the platform it once used to be, but it somehow manage to reposition itself and establish a new life for itself and its users.

Instagram

In 2012, Facebook spent 1B dollars to acquire Instagram. In retrospect, that is an enormously wise decision from Mark Zuckerberg and Co. It would cost Facebook billions of ad revenues if it continues to let Instagram grow into its own social giant.

Instagram is a photo and video-sharing social network that is immensely poplar among youngsters, and most of its users are in the 18-29 age group. As of September 2017, it has reached 800 million Monthly Active Users (MAU) and a whopping 500 million Daily Active Users (DAU). As you may have expected, the dynamics of Divine Discontent, Gresham’s Law and the characteristics of the social media industry is also present in Instagram.

There are a few points I would like to highlight here about Instagram and its future potential (these are not backed by any statistics and are assumptions made based on its similar development to that of Facebook).

Primo, although Instagram is already fairly penetrated in the U.S, Canada and western countries, we can still expect to see it enjoying decent growth in Asia Pacific region and other countries in the world, especially developing countries such as Indonesia and India. With that being said, I believe that it will follow a path similar to Facebook’s monetisation process, in which a substantial amount of ad revenue generated will be from advertisers in U.S, Canada and the West. Even though the share of ad revenue generated from Rest of World (all countries excluding U.S, Canada and Europe) is going to increase slowly over time, it is believed that over the next five years, the majority of ad revenue based on advertiser geography will be from those three regions aforementioned. This causes a noticeable disparity as the major user growth comes from APAC region and developing nations, while the major advertising revenue comes from advertisers in the U.S, Canada and Europe. The same scenario can be observed in the case of Facebook too. More on that later.

Secondo, Instagram is enjoying a near duopoly in early-age users’ preference for social media platform with Snapchat (although Snapchat still have a relatively narrow user base and geographic presence). Its ad revenue as of 2017 is $3.64B, a relatively meagre figure as compared to Facebook Inc’s total revenue of approximately $40B. In spite of that, Instagram’s astonishing growth rate and under-utilisation will allow it to grow its revenue to at least over $10B (a very conservative figure) in the next 5 years. It will be the fastest revenue growth engine in the entire Facebook money-making machine over the next 5 years.

WhatsApp and Messenger

Facebook bought WhatsApp in February 2014 for $19 billion. On the other hand, in-app messaging had always been one of the functions of Facebook in the early days, until it spin this function out and create a separate app solely for messaging purposes called Messenger.

If we compare them side by side, WhatsApp and Messenger each have 1.2B users worldwide. WhatsApp has gained its users over the years, loved by users for its slick interface and user-friendliness. Meanwhile, Messenger managed to gain its clout in a short period of time primarily by leveraging the massive user base of Facebook, which has about 2B Monthly Active Users. 2.4 billion users certainly signifies a large treasure trove for monetisation opportunities for Facebook Inc in its future, however, it’s not a low-hanging fruit for Facebook, and definitely a challenge to Facebook’s management to convert their large user base into lucrative sources of profits. It’s not an impossible task, but the doors left open for monetisation is very limited.

Why is it that hard to make money off messaging apps as compared to social network apps? We must first contemplate consumers’ behaviour while they are using apps for intimate communication with acquaintances. I’ll try to illustrate multiple scenarios to give you an idea of what I’m trying to bring up.

Imagine this scenario, where you are going out with your family and you are sitting in the car looking outside of the car windows. You saw billboards and giant LED screens displaying ads throughout the journey. Do they irritate you? Absolutely no.

Now you are in the cinema, you can’t wait any longer to watch the latest superhero films. But you need to wait for 20 minutes of ads display before the movie starts. Do you feel irritated? Most likely no, and most of the time the ads are interesting!

You are swiping through your News Feed and Instagram feed, almost after swiping through six or seven posts some ads might be shown to you. It may irritates you sometimes but if it’s relevant, you’ll be okay with it most of the time.

And now, you are chatting with your best friend on WhatsApp, or having some serious talk with your boss to work out a solution, you will be offended by display ads in your chat list, or even worse, pop-up ads. Other types of ads such as banner ads are also not appealing to users at all.

The point of listing so many examples here is that the more private and more intimate a thing is to users, the more sensitive they are to objects that intrude their space, which is deemed to be private by them. Therefore, it’s very hard for Facebook to insert ads into Messenger and WhatsApp and can account for only limited potential ad revenue.

Generally speaking, the most important thing that communications app can have is their access to users’ data and messages. Nevertheless, the plausibility of Facebook using users’ messages and data to target ads on users is getting lesser and lesser. Facebook once tried to do that, leaving users no option but to consent to handing over their private messages to Facebook for business purposes if they wanted to continue using WhatsApp’s services. That is proven to be a grave mistake as it causes a massive backlash and lambastes among users around the world. WhatsApp later have no other way but to renounce its decision to sooth the public anger and retain users. Furthermore, the GDPR regulations that was rolled out on May also clearly stated that WhatsApp can only operate in the region if only it respects user data and its services be provided unconditional of users’ consent to the way data will be handled.

If primarily making money off Messenger and WhatsApp with ads is not an option, what other business models can be applied to these two messaging apps for monetisation purpose? Introducing app-related merchandise can be a viable model (as proven by the success of Line in Japan and Taiwan and KakaoTalk in South Korea), but Facebook doesn’t seem to be taking this commercialisation path into consideration. A tantalising and possible alternative is adopting Wechat’s model, which leverages its dominance in communications to build many more services around its app, such as its Wechat Business Platform, Wechat Pay, and Wechat Blogs to form an indisputable ecosystem. However, Facebook also doesn’t seem to be keen on adopting this kind of business model, not announcing or signalling such plans in their financial reports. To be fair, there’s also some feasible reasons behind their decisions. WhatsApp was built on the notion of providing a private,messaging-only interface for users. In addition, its competitive advantage lies in its smooth usability and slick interface. Fitting it into the an-app-for-all model as that of Wechat will probably diminish its usability advantage and causes frustration among its users, who are accustomed to its nimbleness and appreciate it. Besides, the huge cultural differences between Western users and Chinese users means that the success of such a business model in China doesn’t guarantee its success in other parts of the world.

With all these said, is Facebook’s $19B acquisition of WhatsApp a complete mistake? Absolutely not, WhatsApp is more of a strategic purchase that allows Facebook to access the communications market out of America and in other parts of the world. WhatsApp and Messenger will still yield a lot of business opportunities in the future, but as of now and the next few years, monetisation opportunities are limited and therefore, WhatsApp and Messenger won’t be discussed in the remaining part of this analysis anymore.

Obtaining and utilising user data to get meaningful insights 

The core value of Facebook lies in its data – and its massive user data comes from its web traffic. As we have already analysed the fundamental characteristics and traffic of Facebook, Instagram, WhatsApp and Messenger above, this part will be a discussion of Facebook’s ability to collect and aggregate user data. Because the main profit engine of Facebook Inc is its Facebook app and Instagram app, we will be emphasizing on these two apps (WhatsApp and Messenger doesn’t collect their users’ messages for targeting purposes).

If you’ve always wondered why Facebook and Instagram can show you relevant ads most of the time, take a look at the amount of data it collects though your activities on their apps: your posts, your videos, your IP address, your handheld device, your interest, your likes, your shared posts, your contact list, your payment history, your search history etc. It probably know you better than yourself. What’s more is that it can even know which website you have just browsed if the websites choose to install Facebook Pixel! It is almost undeniable that Facebook has the most complete set of user data among all websites and apps that profits primarily from adverts, except Google.

But an aspect that couldn’t be ignored is the ability that Facebook possess to collect user data as freely as they want to. Last time, Internet companies including Facebook can take advantage of the ignorance of their users and obscure ad preferences settings. Consent to give away all your account data to Facebook is the default option of every user account. Privacy policies are hard to understand using abstract languages, and that doesn’t matter to most users, as they simply click ‘Agree’ to the privacy policy of every app most of the time.

Things started to change about two years ago. More and more privacy activists are ranting and criticising the shady practices of Internet Giants to keep their users in sleep. Increasing number of uses start to pay attention to what Facebook is doing with their data. The issue of user privacy came to a crescendo in 2018 after the Cambridge Analytica scandal emerged on the headlines of all presses. Shortly after that, the General Data Privacy Regulation (GDPR)  was officially rolled out in Europe (Yes, the rule that causes ur mailbox to be flooded with privacy policy updates emails). The strictness of  GDPR rules has conveyed European regulators’ attitude towards tech giants that breach users’ data. The fine of noncompliance to GDPR can go up to 20 million Euros or 4 percent of annual global turnover, whichever of both is highest. Apart from that, the current regulation states clearly that pre-ticked boxes or any other method of default consent is no longer allowed and explicit and clear consent is required from users. Also, consent to processing a precondition of a service must be avoided, meaning that irregardless of whether consent is given, services must still be provided to all users equally. All of these rules signifies a large shift: the power of obtaining data by Internet companies is going to gradually diminish, and the the power of controlling their own data by users is increasing.

It means that tech giants can no longer avoid clear communications with their users and they must obtain user consent in an explicit manner. Does that mean game over for Facebook and its peers? Far from it. There are two forces working in the favour of Facebook: user ignorance and user laziness. Even though awareness about user privacy has increased in the recent years, the majority if internet users still remain oblivious to the rights that they have towards their data and the obligations that tech companies need to fulfil. They still possess the thinking that if they do not agree to the those privacy policies, they won’t get to enjoy the free services of Google, Facebook and Instagram anymore. Hence the only way is to give all their data out. Although after some time most users may be aware of their rights and power, it’s likely that they still won’t deny Facebook’s access to their data, simply because they don’t feel the need to do it. They won’t be willing to spend even a fraction of their time to re-adjust their ad preferences. They also don’t feel that it’s a big deal to give away their data to tech companies, it’s not like the tech companies will sell their data to fraudsters and criminals. Even if tech companies hand user data to government for national security purposes, they will think that:”at least I’m not the only one!”.

Based on these two factors, I infer that over the next few years, user consent to obtain data won’t be a problem that threatens Facebook ads model. In some sense, GDPR may even be a plus for Facebook (more on that later).  However, user sentiment definitely poses potential risk to undermine Facebook’s ad business. As mentioned above, users won’t deny Facebook’s access to their data, simply because they don’t feel the need to do it. Once they are triggered and feel that giving away their data could put them in a disadvantaged position, the outcomes will be altered very quickly, and Facebook is doomed to fail in the case of a massive data-bank run.

In short, obtaining user data is believed to be smooth and not a problem in the future, but a time bomb such as this must be monitored and contemplated meticulously from time to time.

Placing ads in the social media platform targeted on their user base

Now comes the integral part of Facebook’s money-making machine. The ability to convert user data into insights for advertisers and convert services provided into ad products is the primary source of Facebook’s ad revenue (Apart from advertising revenue, Facebook also makes money from in-app payments and Facebook games. But it wont be part of the analysis because the contribution of payments revenue is immaterial to Facebook Inc’s total revenue).

To understand the entire digital advertising landscape, let us from explore it from the perspective of an advertiser. Next, we will have an overall view of Facebook’s ad network briefly and move on to the factors that shape the advertising industry.

Advertiser Incentives

As known by everyone, an advertiser’s main objective will always be obtaining the highest return-on-spending on their ads. In a world with perfectly rational agents, advertisers will keep searching for as many publishers that offer the potential of great return-on-ad-spending, test their ads on all of those publisher’s ad inventories, and finally choose to advertise with publishers that offer the highest return-on-ad -spending. However, in reality, advertisers will simply choose several reliable and reputable ads publisher to advertise their products/services. Later, the advertisers will likely stick to the publishers that offers the best results out of the several publishers that they’ve worked with and allocate more budgets to the publisher with great results.

Facebook Ad Network

fb_ad_network.jpg

Diagram: Facebook’s Ad Network 

As seen above, Facebook advertising network comprises of two main parts: Facebook Business Pages, which enables businesses to connect directly with consumers, and Facebook Ads, which enables businesses to advertise on their ecosystem. The ecosystem includes Instagram, Facebook, Messenger and Facebook Audience Network (FAN). In addition, FAN includes the Facebook Instant Articles network, a feature in the Facebook app, third-party apps and websites which collaborated with Facebook and depended on Facebook to channel ads into their websites and apps, and also in-video streaming ads, which insert ads in videos played on Facebook. I won’t dive deep into what the Facebook Instant Articles network is, but here’s a brief excerpt from Wikipedia that sums it up pretty clearly:

Instant Articles is a feature from social networking company Facebook for use with collaborating news and content publishers, that the publisher can choose to use for articles they select. When a publisher selects an article for Instant Articles, people browsing Facebook in its mobile app can see the entire article within Facebook’s app, with formatting very similar to that on the publisher’s website

To get a more in-depth view of what the Instant Articles is, you can browse its page on Facebook if you want to.

Facebook usually recommends advertisers to advertise on the entire Facebook Ad Network, allowing Facebook’s algorithm to place advertisers’ ads in the Facebook Ad Network accordingly, instead of the advertisers themselves choosing where to place the ads on their own. By doing so, Facebook is able to bundle the inferior and cheaper FAN ads with better quality, more expensive native ads on Facebook and Instagram as a package. As Facebook native ads and Instagram native ads are the core products and core competencies of Facebook Inc’s product offerings, we will only be emphasizing on the two products mentioned above in our research piece.

After having a simplistic view on advertisers’ decision making process and the Facebook Ad Network, we will introduce the factors that shape the advertising industry, and discuss various important aspects and topics revolving the aforementioned factors that characterises the industry.

Advertising Industry Dynamics

There are three primary factors that constitutes that supply and demand of ads inventory of different ad publishers: traffic, data and ad elements

Traffic is the king of advertising. Think of why advertising has shifted away from traditional media such as billboards, television, radio broadcasting, newspapers to Internet platforms such as Google, Facebook and Youtube. In traditional media, the number of people and potential customers that can be reached is relatively limited. For instance, there’s a ceiling in the number of people that will pass by the billboard everyday due to geographical constraints. There’s also a ceiling in the number of people that read a particular newspaper in a single day, given that most of its customers are locals. The advent of the Internet opens up a whole new world, enabling Internet users around the world to connect to various websites irregardless of their nationality and geographies. This, alone, magnifies the opportunities and traffic of Internet platforms as compared to traditional advertising options. In effect, advertisers can increase their return on ad-spending multiple folds higher at a cheaper price and with a more scalable method if they opt to advertise with Internet companies. All this is only made possible with the robust web traffic of Internet platforms.

It’s because traffic is the core value in the entire advertising value chain, a ‘smiling curve‘ can be observed here:

Smiling_Curve

Diagram: Ad Publishers command the greatest power in the smiling curve

The second dynamic that affects the supply and demand of different ad inventories is user data. The reason why Google can charge higher on their ads as compared to Facebook is because of the user data they command. Imagine how much Google know about its users when it knows what you want to ask even before you finish typing what you want in the search bar. This is because when you want to know about everything, you ask Google before anyone else. You want to have lunch in a nearby Japanese restaurant, you Googled. You are searching for a white collar t shirt, you Googled. You want to know more about programming languages and take up an online programming course, you Googled. With an unprecedented amount of user data and the accuracy and reliability of it, it gains a strong foothold in the advertising industry, owning about 43% of market share.

The third factor that governs the advertising sector is the required elements to have effective ads and directly links to the return of spending on ads. The underpinnings of  successful ads comprises of at least one of these five elements:

  • Super-exposure
  • Perfect crowd targeting
  • Retargeting
  • The State of Nonchalance 
  • Super-Interactiveness

Super-exposure
Super-exposure is derived from a concept in psychology named the ‘mere exposure effect’. ‘Super-exposure’ points out that the targeted customers must be exposed to the relevant ads at least seven times to catch the attention of targeted customers and occupy a position in their mind to generate awareness towards a brand. Examples of success are ubiquitous billboards with the same ads and TV ads where the ads are often circulated in a long enough time period and many enough times to induce brand awareness

Perfect lookalike targeting
Crowd targeting, which is also named as ‘lookalike targeting’ means modelling customer groups with shared characteristics and behaviour, and place ads that are targeted towards this customer group. Judging by its name, you can know that perfect lookalike targeting simply means a publisher that enables a near-perfect targeting ability of the customer groups. For example, niche magazines such as TopGear(an automobile magazine) has a very specific customer group: Males that are obsessed towards the automobile industry, familiar with it and love getting the latest updates in the industry. The ad inventories of this magazine is naturally tantalising to automobile spare part suppliers and automobile manufacturers because of its niche crowd that enables perfect crowd targeting.

Retargeting
Retargeting is a form of online targeted advertising by which online advertising is targeted to consumers based on their previous Internet actions. Many ad-based websites now offer retargeting service. Facebook Pixel is a great example of retargeting. Once you saw an ad, clicked on the ad and is redirected to the advertiser’s website, Facebook Pixel will know that you’ve shown interest in the ads. Later, Facebook will show you tailored ads of the previous website specifically targeted to potential customers that engaged with the ads before, as they are more likely to be converted into sales than those users who never engaged with the ads at all. In this piece of analysis, Google’s superior ‘demand fulfilling ads’ that drives instant conversion of sales are also classified under the retargeting element. 

The State of Nonchalance (TSON)
‘The State of Nonchalance’ is one of my observations of user behaviour and another term coined by myself. TSON is the state where users do not have an end goal in mind or  carrying out any task at the moment the ads are displayed towards them. Instead, users are on a casual state of mind and feeling relaxed while the ads are displayed to them. A great example of TSON is Facebook native ads, which is ads displayed on Facebook news feed. While Facebook users are swiping through their news feed, they are usually in a casual and relaxed mood, which helps in the absorption of ads. A product which possess the opposite element on TSON is ads displayed on Instant Articles. Users who are browsing Instant Articles are committed to an end goal: finish the article they want to read. Therefore, the readers will swipe over the display ads on the article page before the ads can finish loading on the page.

Super-Interactiveness
Super-interactive ads are ads that are creative, lively, and attractive enough to grab the audiences’ eyeballs, aka ‘the ads that are so interesting you don’t even want to skip it’. Ads that are very creative and nice to watch are often extremely rare, but the format of the ads will also greatly increase the attractiveness of your ads. For example, video ads and interactive Snapchat filter ads are definitely more enjoying to be shown as compared to typical display ads and banner ads. That’s also why video is becoming increasingly popular with ad publishers

Phew… Finally, we’ve finished going through all the elements for successful ads. Let’s move to the next part and examine the competition map of Facebook Inc’s ad products.

Competition Map (对位图)

Facebook Inc’s competition can mainly come from two areas: revenue allotted to traditional ad publishers and ad revenue distributed to it among ad publishers that provide awareness ads.

Any one who is attentive and observant in their lives can definitely identify the tailwind working in  Facebook’s favour: the decline in usage of traditional media (which are also traditional ad publishers). More and more people are cutting the cords; Newspaper circulation are declining at a steady rate. Let’s not forget,again, that Traffic is the king of advertising. It can be logically reasoned that more and more share of the ad revenue pie will inevitably go to digital advertising. 

competition_map.jpg

Diagram: Competition Map (对位图)

P.S: Sorry for the messy side notes and scribbles on the draft, just kindly ignore it

Because the main goal of all advertisers is to convert ads spending into sales, the more likely an ad can drive conversion, the higher the price of the ad inventory. Therefore, ads can generally be differentiated into two types: ads that drive brand awareness (awareness ads), which is cheap and ads that drive instant conversion (conversion ads). The marketing funnel can help us to understand this better. As the funnel goes down, the more valuable the elements is.

marketing-funnel

After all the previous discussions, we have already known that Facebook ads are awareness ads. Its native ads, Instagram’s native ads and ads on FAN works primarily to deepen brand awareness on consumers’ mind. Now, let us examine which of the ads elements does Facebook native ads possessed.

  1. Super-exposure
    • Facebook and Instagram’s news feed enable native ads to be displayed to targeted users for several times when users are swiping through their news feed continuously
  2. Perfect crowd targeting
    • While Facebook’s crowd targeting is not perfect, it currently offers one of the best and the most accurate lookalike targeting option due to the massive user data that it has from its large user base. Although it can be argues that other niche ad publishers such as trade magazines offer even better and a more specific crowd that Facebook, their ads monetisation opportunity is also fairly limited due to its niche customer group. In stark contrast, Facebook encompasses crowds and customer segments of different age groups, characteristics, behaviour and interests. The combination of a broad user base and refined user data enables one of the best targeting service coupled with the broadest customer groups among all publishers
  3. Retargeting
    • While Google is the indisputable champion in driving instant conversions, Facebook is also improving on driving conversions through better retargeting efforts. Its new ads format such as the Dynamic Ads series and tools for retargeting purposes such as Facebook Pixel have dramatically improved its retargeting ability and move Facebook ads down from the ‘Awareness’ funnel to the ‘Consideration’ funnel.
  4. The State of Nonchalance 
    • Facebook and Instagram is one good example of TSON ads. However, most of Facebook Audience Network (FAN) websites,apps and Instant Articles are anything but the antithesis of TSON ads. That’s why FAN ads is cheap and of low-quality. It can only survive through bundling with high quality native ads
  5. Super-Interactiveness
    • While Facebook ads aren’t by any means super-interactive and that type of ads that will make consumers willingly watch it, it is moving towards the correct direction through its evolution of ads type. New ads products introduced following new features introduced (such as Instagram Stories) contributed to more interactive ads. Besides, Facebook evolution from a people-oriented social network to an increasingly video-oriented social network indirectly implies that new video-related ads products will be more interactive and visually appealing. Higher interactivity naturally leads to higher profit margins

In short, all the successful ads elements that Facebook ads possess is the key to its success and having all five elements is its strongest competitive advantage compared to other ad publishers which also compete on the grounds of awareness-driven ads. Facebook is already not merely an awareness-only awards. Facebook and Instagram’s ad products are evolving from the purely awareness funnel more to the consideration funnel through its extremely solid ads elements. That is a great leap towards the path of higher margins. While I won’t go deep into each of Facebook competitors’ profile and analyse them one by one, I do think that there is two competitors worth mentioning individually: Amazon and Programmatic Ads.

Amazon

Although Amazon’s advertising revenue is only 2.5% of its total revenue, it is definitely the 800-pound gorilla that can’t be ignored by the advertising landscape. Its large amount of web traffic and user data comparable to Facebook and Google makes many people thinking that it may be the third-largest dominant force in the digital advertising space. My conclusion here is that Amazon can become a large player in the space of advertising, but its direct competition with Facebook is minimal. As previously discussed, Facebook is the kingpin of awareness ads, and Amazon is gaining ground in a different arena. Amazon’s native ads is most compelling to vendors and merchants on Amazon wishing to sell as many of their products to vast Amazon shoppers. Therefore, Amazon’s ad revenue comes from sources in its own ecosystem, consisting primarily vendors of products only on Amazon. Its display ads poses direct competition to Facebook’s FAN. However, we must know that FAN is only a negligible part of Facebook’s revenue sources and Amazon’s display ads is an even smaller portion of its total ad revenue. Some investors also talked about how will Amazon Echo displace Facebook and Google in the advertising industry if its smart speakers become the dominant search engine in the future. I think that is probably not a problem to be worried about in the next 3 to 5 years as even if Amazon’s smart speakers become the dominant search engine, that will most likely take place at least 5 years from now (which is out of the stated investment horizon).

Programmatic Ads

What are programmatic ads? “Programmatic” ad buying typically refers to the use of software and platforms such as Demand-Side Platforms (DSP), Supply-Side Platform (SSPs), and Ad Networks to purchase digital advertising, as opposed to the traditional process that involves RFPs, human negotiations and manual insertion orders. I know this definition doesn’t serve well enough as an explanation at all, and believe it or not, the actual process of  programmatic ads buying is even more complicated and convoluted than this. As the saying goes, a picture paints a thousand words.

programmatic_ads.jpg

Diagram: Programmatic ads buying process – involved parties

Although the drawing quality of the diagram is extraordinarily deplorable, I believe 99% of you still won’t really understand the entire programmatic ads buying process after looking at this flow chart (In fact, some media buying agencies also can’t fully understand how the ad buying mechanism works). That doesn’t matter, though. The only thing you need to keep in mind is that the entire programmatic ad buying chain is non-transparent, convoluted and the performance of ads is hard to measure.

The rise of programmatic ads can be attributed  to the tremendous shift of ad revenue to digital advertising in recent years. However, there are a few issues that stymies the future growth of programmatic ads and I seriously doubt that they can grow continually at the same growth rate in the previous years.

One of the issues that is plaguing programmatic ads is its opaque buying process through a real-time bidding process. It makes it hard for advertisers to track where their ads are placed and whether their ads are targeted accurately to the desired lookalikes. This make reviewing and measuring ad performance even more difficult. On top of that, the buying process of programmatic ads contains many risk such as frauds, manipulations of performance metrics, and Internet bots performing suspicious activities.

Next, programmatic-ads-buying is a long value chain that typically involves many parties and middleman such as DSPs, SSPs and Ad Exchanges. These middlemen take small slices of the advertising fee respectively. In aggregate, these small slices add up to a big chuck of expenses. The chart below shows how much of the allocated advertising budget set by advertisers get to the hands of ad publishers in the programmatic ads buying process:

programmatic_buying_cut

To repeat the quote again, Traffic is the king of advertising. That’s why if Facebook and Google build an entirely private advertising ecosystem tailored specifically for their own aka ‘walled gardens’, they are indirectly squeezing the profits of players in the programmatic-buying field. And the two behemoths did exactly this, with Facebook having its own advertising network and Google owning an entire programmatic buying ecosystem of its own. With the ad buying process conducted completely in their own efficiently-run ad ecosystem, the issues of opacity and frauds go down dramatically. Facebook and Google also provide analytics service for advertisers to measure ad performance substantially better. Furthermore, with the vast user data and web traffic they dictate, their native ads are of better quality than 80% of programmatic ads on other websites, as a substantial number of programmatic ads includes low quality ads that doesn’t contain either of the required ad elements.

fb_google_ecosystem.jpg

Diagram: Facebook and Google’s walled garden

Last but not least, the GDPR which comes into effect in May hits not the Internet giants the hardest, but services and platforms revolving the programmatic buying process. As Facebook and Google have direct communication with their users, they are more likely than any other platforms to get users’ consent for advertising purposes. That’s not the case for programmatic buying platforms. They don’t have direct relationship with Internet users and are much more vulnerable to the risk of not being able to gain user data for targeting purposes, which is a major threat to their business model. Although programmatic buying related companies have once and again said that the effect of GDPR in the Eurozone is minimal to them, they are definitely put in a more tight position than either Facebook or Google.

Last Notes

  • Facebook Inc still offers the best value for money among the awareness ads landscape for its broad user base and precise targeting
  • A continual shift or more ad revenue to digital advertising and the plausible decline of programmatic ads provides room for even more ad revenue growth in the future
  • Facebook’s competitive advantage and solid ad elements enables it command more and more high profit margin ad products
  • Potential threats from new ads format stemming from disruptive technologies such as AI, Blockchain and VR/AR must be monitored and gauged from time to time. The huge openings and leakages that sink the ship is best detected when they are still small cracks. And for investors, the best thing to do when you see that there are cracks in the ship and the captain (management) is not able to rectify it, is to jump ship before it sinks.

Management

I believe that most of you must be familiar with at least two of the five executives of Facebook Inc: Mark Zuckerberg and Sheryl Sandberg. Anyway, here is a list of the main executives of Facebook Inc:

  • Chief Executive Officer, Founder – Mark Zuckerberg
  • Chief Operating Officer – Sheryl Sandberg
  • Chief Financial Officer – Dave Wehner
  • Chief Technology Officer – Mike Schroepfer
  • Chief Product Officer – Chris Cox

Facebook Inc’s management has lead Facebook well throughout the years and they definitely have a stellar track record, which is reflected in the stock price. The management team also ensured that the company is efficiently run and financially sound. With these in mind, let us review Facebook’s management’s track record and how they handle things in the past to have a peep on how they will likely perform in the future.

When Instagram first emerged as a nascent social network app, Mark Zuckerberg and Co realised that Instagram has a huge potential to become the next big thing in social media. Its slick and elegant  interface, easy-to-use features and photo-sharing characteristics make Instagram the darling of teenagers and millennials. Hence, they decided to bought Instagram in 2013 for $1B. At that time, it may seem like a skeptical acquisition, but in retrospect, this acquisition become one of the most lucrative growth pipeline for Facebook, bought only at a price of $1B.

Facebook’s acquisition of WhatsApp, although costed approximately $22B and is not acquired in its early-stage, does seems like a sensible move too. First come the visionary reason of acquiring WhatsApp, if Mark Zuckerberg’s means it when he said Facebook’s mission is to truly ‘connect the world’, then WhatsApp is a perfect puzzle piece to be fit into the ‘Connect the world’ puzzle of Facebook. It has nearly 600 million of monthly active users as of when it is acquired (source: Statista), what’s more is that WhatsApp’s user base is spread throughout the whole world, complementing Facebook Messenger’s concentrated user base in the U.S. From a perspective of business and strategy, buying WhatsApp prove to be a meaningful move too. Facebook can amass even more user data and information from the vast 600 million WHatsApp users (that is before serious talks of regulations and the insurgence of GDPR). On top of that, WhatsApp can pose potential threats to Facebook as a communication network. For instance, it is in the same advantageous position (possible even more) as Facebook to roll out additional services and features (refer to Wechat’s business model), and extend into many more parts of their users’ life. In spite of the hefty price tag, the WhatsApp move is feasible.

When Snapchat crack into the social media market in its early days, Facebook immediately saw its potential and offered to buy it at a price of $3B in 2013. Nonetheless, Snapchat turned down the offer. Facebook’s solution? Duplicate Snapchat’s most interesting feature in their own social network and modify it to be even better than its predecessor. This strategy, although doesn’t looks good, proved to be a tremendous success. Instagram’s story count now exceeds Snapchat’s story, and time spent on Snapchat has been declining after Instagram rolled out its new ‘Story’ feature. This wounded Snapchat’s core competitiveness and lucrative business opportunities, while helped Facebook Inc to unlock more products for advertisers.

All these successful moves ensured that Facebook enjoyed a near-monopoly dominance in the social media market. A confluence of prudent acquisitions and successful expansion of product features established Facebook’s firm position in the market. This also proves that we can most probably count on Mark Zuckerberg and Co to maintain its dominant position in the social networking industry over the next 5 years.

Facebook is also far-sighted on its future, announcing its 5-year and 10-year development roadmap. Its long-term goal will be betting on Virtual Reality (VR) technology to help connect the world in an even more interactive way. To achieve this, it is spending huge amounts on VR technology and productions of VR content. Although it’s too early to say, Facebook is currently a strong player in the VR-gaming industry and extending its tentacles into day-today applications of VR technology. It also proves that Facebook has a clear direction where it is heading to in the future.

Apart from maintaining its dominance in the social media market, Facebook management also responded well towards scandals and public outrage. The management planted the seed for the fake news scandal and Russian meddling event when it decided to make news one of the pillar of news feed and failing to take the responsibilities of a news publisher in ensuring the credibility of those news. It saw itself as merely a platform for people to disseminate information and not a publisher that makes sure the news on its platform is authentic. The painful consequences such as the outlandish fake news scandal and reports of Russian meddling in the 2016 U.S presidential election makes Facebook realise its grave mistake. To extinguish voices for more regulation on Facebook, Facebook endorsed its role to filter unbelievable information and spend huge sums in its fact-checking programmes to curb the spread of more fake news, fake accounts and political meddling in its platform. Mark Zuckerberg also said that Facebook will focus on fixing these problems  in the next three years to sustain the health of its ecosystem. To give him credit, spam accounts and fake news have been steadily declining after Facebook rolled out efforts to put a full-stop on this issue.

Mark Zuckerberg and Co also handled the Cambridge Analytica scandal well enough, managing to sooth the public’s emotion and prevent their worries about privacy from looming big. His testimony in Capitol Hill also fared well, having no regulations imposed to Facebook following his testimony in Congress, while giving the Senators and the public an acceptable explanation of the scandals and attitude towards the data-leakage crisis. Facebook, although had much responsibility in the crisis, was perceived to be more of a victim of the scandal and the company that breached its rules.

Facebook’s management has long known about the importance of gaining user consent for ads targeting. The enforcement of GDPR pushes them even further to consider clear communication and mutual understanding with their users. Therefore, aside from complying with privacy regulations in the Eurozone, Facebook goes a step further to make its data-oriented advertising business model even more transparent to users throughout the world. It reviewed its privacy policy and drafted them using more simple and concise language which users can understand. It also communicated with its users and give them clear information on how they can adjust their ad preferences, what Facebook actually does with their data, and how users can download their data sheet to see what information Facebook has about them. All these new measures regarding data transparency and effective communication with users gives Facebook more cushion to make their users comfortable about handing data to Facebook. This is definitely a smart move and sensible decision-making from management.

Management candour is definitely an essential aspect to all investors. Fortunately, Facebook’s management is honest and open about their goals and financial results with investors. They don’t try to hide anything fishy, mask bad results and dodge questions from investors in earnings calls. They had also always make credible statements about future earnings outlooks and future expenditure projections. As a side note, Facebook has a great track record of management stability, with its executives staying in the company more than 5 years each and low executives turnover.

Facebook has also kept the company well-operated and has built a great company culture to fuel its future development. It continue to be a place that attracts talented employees and guaranteed innovation.

We had reviewed management’s compensation plan and concluded that management compensation is reasonable and that management has aligned incentives with the company’s shareholder. Facebook Inc also has a board filled with prominent directors. Although many of them are from Silicon Valleys and less diversified, we believe that the board of directors carried out their task independently and responsibly, and also did a great job on overseeing management’s performance and decisions. One thing to highlight here is that the CEO and founder of Facebook, Mark Zuckerberg holds more than half of Facebook’s voting right, constituting about 60% of voting power (including proxies). While this means that all of Facebook’s governance and structure is under his absolute power, we believe that as a founder and and major shareholder of the company, Mr Zuckerberg will be a reliable and open-minded leader that will determine the final outcomes that is best for the company. Indeed, no one is more suitable than the founder to have the visualise the company’s future and steer it into a great path.

It is undeniable that Facebook has focused less and put less resources on futuristic ‘moonshot projects’ and extend its arms into other traditional industries such as Google and Amazon. From management’s discussion and their past performances, it can be inferred that they will continue to focus mainly on improving their social network ecosystem and the only huge project on future technology is Oculus VR (even though, strictly speaking, its VR tech is also on connecting the world better), its AR and AI technology are both oriented towards new features on its social network platforms. This makes Facebook to have a relatively lower PE than other tech giants such as Google and Amazon. Although some may view this as not innovative and a minus point, we are  comfortable with its conservativeness and give more weigh and attention to Facebook’s ability to constantly improve its ecosystem and comes up with innovative ad products to maintain its dominant position in social media market. (as a reminder, our investment horizon is 4-5 years).

Although the management had committed mistakes over the years, they learned painfully from those past mistakes and took action accordingly to prevent similar issues from happening in the future. Each mistake made them more experienced and careful in their way of handling the Facebook social network ecosystem and their success definitely outweighs their failure. All in all, we are satisfied with Facebook’s management’s performance and we believe that they can be relied to lead Facebook in the future.


Financials

If Facebook’s fundamental soundness is impressive enough, its financial stability will shock you even more. All ratios and measures point to a company will steadily surging profits, zero debt, and healthy cash flows. Its financial soundness is what makes its financial reports so easy to read. Furthermore, clear and concise languages are used throughout its reports, management remarks and comments are candid too. Here is a brief overview of its financial health as of 31 December 2017:

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Revenue Y-o-Y growth: 47%

EPS Y-o-Y growth: 54%

Free Cash Flow Y-o-Y growth: 50%

Current ratio: 12.9 : 1

Debt / Equity ratio: 0.14

Assets / Liability ratio:  8.3 : 1

Cash Conversion Cycle: 1.14 days

Intangibles / Book Value: 5%

Long-term debt as a % of invested capital: 8%

Cash, Cash Equivalents and Marketable Securities: $41.71 Billion

Operating Cash Flow / Sales: 60%

Operating Cash Flow / Assets used to generate cash flow: 71%
( Assets used to generate cash flow = P&E + Intangibles + Goodwill )

Liability Coverage Ratio: 6.4

% of cash generated by daily operations = 66%
( Operating Cash Flow / Cash inflows from operation, investing and financing activities )

ROA = 18.8%

ROE = 21%

ROIC = 19.7%

*  83% of Facebook’s long-term debt is made up of income tax payables

*  No signs of Assets – Liabilities mismatch is found

*  Stuck to the same auditor for years and no changes or dubious signals in the auditor’s       comments

*  Consistent in their accounting principles and measurements of key user metrics

*  Most of their marketable securities are divested in liquid financial instruments such as AAA corporate debt, U.S treasuries and government agency treasuries

*  No signs of large scale insider-selling / insider-buying activities is observed

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As shown above, Facebook’s business model enables it to amass large amount of cash that is more than enough to finance its daily operations. Its advantageous cash position also enables it to acquire interested companies without external financing.

As for the costs and expenses of the company, the revenue of Facebook is growing more than its operating expenses every year. Its EBIT as a share of total revenue is growing steadily every year, with a stunning figure of 49.8% for 2017. Such stunning operational efficiency can be achieved a large part owing to its Aggregator characteristics, as defined by Ben Thompson of Stratechery. Facebook spent years building its enormous social media ecosystem and the previous few years are the harvesting year for it. Its industry characteristics and network effect affected its cost structure tremendously: huge upfront infrastructure costs, low customer acquisition cost, minimal marginal cost of serving an extra user, zero distributional cost and a high ROIC without substantial reinvestment. Its supply-side economies of scale also help it to get network infrastructure and data servers at an extremely cheap rate. That’s why Facebook’s advertisement revenue growth can outpace its expenses by miles.

In short, financials is the aspect that should be least worried in an investment evaluation of Facebook. We expect its financial stability to continue over the next few years and its healthy cash position can help it weather all storms and crises in the future.


Critical points, future prospects and valuation

Critical Points

With all the praises to Facebook, there are certainly some areas that should be always monitored and evaluated. These are the critical points that can undermine Facebook’s business model and future growth.

  • Macroeconomic factors and economic recessions
  • Facebook’s ability to retain users and user engagement in the future
  • Competitors with substantial web traffic that can become another large force
  •  Facebook as a ‘first-choice’ option to advertisers
  • Regulations and data privacy rules
  • Users’ sentiment and willingness to hand over their data
  • The effectiveness of in-app ad blockers and number of users who use it
  • Facebook’s ability to acquire potential threats and copy their features if they can’t acquire it
  • Failure to fully monetise WhatsApp and Oculus VR
  • Departure of key executives
  • Disruptive technology that can transform how people interact and disruptive technology that dramatically improves ad performance
  • Facebook’s ability to constantly come up with new ad products

All these aspects should be gauged and monitored from time to time. Any first signs of such events happening deserves a re-evaluation of the company’s fundamental and the ability of management to cope with such events.

Future Prospects

Investing is all about the future, not the past. There begs the question: What is the future of Facebook? Let us look at the projects currently known that may be a revenue driver in the future 5 years:

  • Instagram ads
  • Facebook Marketplace
  • WhatsApp Business and Messenger Business
  • Oculus VR
  • Roll-out of features that increases product pipeline
  • Ads optimisation
  • Facebook Watch & Show
  • Facebook Group
  • Facebook Dating

According to observations of current conditions and my inferences, the areas that will contribute to material revenue growth are Instagram Ads, Roll-out of features that increases product pipeline, Ads optimisation, Facebook Watch & Show, and Facebook Dating

Facebook Marketplace is a nice feature to add to the Facebook Platform. However, it will not be one of the quintessential feature that people surf Facebook for. Because commerce is conducted in the form of discovery, not inquiry (i.e: Amazon), Marketplace will only be the extra feature that Facebook provided. Facebook won’t be marketplace-oriented. Besides, the profit margin made from Marketplace transactions is going to be typically low. These two factors decided that Marketplace will not be the significant revenue driver of Facebook. WhatsApp Business and Messenger Business will likely enjoy strong growth and be embraced by more and more businesses to communicate directly with their customers. But as mentioned before early in this piece, monetisation opportunity remains rather limited. That’s why this research piece thinks that Facebook probably can’t come up with a great monetisation plan for these two apps in the next five years, and therefore, should not be taken into serious consideration in terms of revenue growth. Facebook management had already explained before that Oculus VR will be a  project for its 10-year roadmap, so it’s unlikely that Oculus VR will manage to reach mass adoption by consumers and reap great profits in the next five years. Nevertheless, Oculus remains a great opportunity for Facebook and it should be monitored during the next five years to determine how is it progressing. If it progresses well in the next few years and signals a great probability of mass adoption by the public, it will undoubtedly  be the golden goose for Facebook in the subsequent five years, beginning the second growth phase of the Facebook empire. Facebook Group is one of the main feature that attract users to spend more time on Facebook (as mentioned before, regional groups and interest groups). Facebook also recently announced that it is experimenting on a revenue-sharing model with group admins to collect a monthly subscription fee for premium groups that have exclusive contents. The other side of the story, meanwhile, is that subscription groups are just minorities among the many groups on Facebook, and one of the reasons that Facebook groups thrive is because they are free! Due to this reason, we concluded that the impact on Facebook Group subscriptions will have negligible impact on its bottom line.

After discussing the why-nots, let’s dive into the main revenue driver for the future five years. While Facebook is already a video-oriented social networking platform most of the time, revenue from videos has not reach its full potential. On top of that, Facebook is spending aggressively on video contents on Facebook to build its own video ecosystem, named Facebook Watch & Show. Facebook Watch & Show is providing content creators a chance to popularise their content on Facebook in the form of shows that contain episodes. As Youtube is already crowded by well-known Youtubers that enjoyed first-mover advantages, it is harder and slower for a completely new content creator to build their fame on Youtube as compared to last time. In this scenario, Facebook presents a tantalising opportunity for first-time content creators to accumulate their popularity and spread their work. Indeed, Facebook’s socialising characteristics and sharing feature also enables videos to go viral like a wildfire through compounded sharing. A few content creators such as Wil Aime and QPark have already build their fan base and popularity through Facebook’s video platform and so, it is expected that Facebook Watch & Show can attract more and more creators and grow significantly in the future years. Besides, video-based ad products are also more interactive and typically have a higher chance to attract users’ attention, therefore the shift of more advertising revenue to video ads is anticipated. Based on the above reasoning, we believe that more video-based ad products and monetisation (i.e: revenue-sharing with creators) will follow if its video ecosystem can grow as anticipated.

Another catalyst for growth is value optimisation of ads, mostly through better retargeting efforts, such as Dynamic Ads on Facebook. Value optimisation of ads can be achieved by having more user information and data; and we believe that Facebook’s management has the ability to come up with innovative ads that present more value for advertisers. High-value ads will definitely attracts adoption of more advertisers and command higher profit margins for the company. We anticipate Facebook’s dynamic ads series to continue to expand and more similar offerings to be rolled out.

In the last few months, Facebook had announced its ambitious plan to go into the online-dating market. This move, although shocking, should not be all that shocking. Facebook has a large pile of data about user interests, user preferences and user behaviour. Matching is the core of all dating apps. Whichever dating app that can create a matching mechanism several times better than its competitor can dominate the online dating market. Hence, if Facebook can successfully utilise the data it possesses to make the matching mechanism more efficient than other competitors in the dating market, it can be yet another market leader. Furthermore, the dating feature will be inside Facebook’s app, so that its already-enormous user base will be one of its competitive advantage. This move is a sensible one, leveraging Facebook’s advantage to gain ground in a nascent and growing market, with low upfront cost and development expenses. In the worst case scenario, Facebook’s matching mechanism will be of the same quality of other dating apps, and even in this case its sheer size will still help it to gain a foothold in the dating market. A low risk-high reward move indeed. Although Facebook has publicly announced that it won’t collect any user data and make money on this feature, great monetisation and strategic opportunities still lies ahead. The most important thing is to generate regional network effects and build a well-functioned dating platform, and profits will follow.

Last but not least, another robust pipeline of growth that can be anticipated and highly probable to materialise is the expanding growth of Instagram ads. Facebook just started mass monetisation effort on Instagram in 2016 and Instagram now commands $3.64B of revenue. As more advertisers embrace Instagram, and Instagram ads generally have a higher profit margin as compared to Facebook ads, it is expected that its contribution to revenue will continue to grow. With this said, revenue growth from Instagram is already anticipated by the markets and we believed that it’s already fully priced. Nonetheless, it is believed that Instagram’s management will have the ability to roll out more features on their products to attract users and increase their product offerings to advertisers. Although the market is excited and holding high hopes on the newly introduced IGTV feature, a video platform, we hold a more sceptical and less optimistic view on it. This is because IGTV is more of a platform for Instagram celebrities and influencers to promote themselves and engage with more Instagram users, we hold the view that it will continue to be this kind of niche platform (resembles more of Snapchat’s Discover feature) rather than an all-encompassing platform such as Youtube, or even Facebook Watch & Show. The monetisation opportunity is definitely there, but less significant and of minimal impact.

After discussing the potential growth areas, we must anticipate the expenditures made in the future five years. Facebook’s management had explicitly stated that huge amounts of investment will be spent on video content and fact-checking programmes in the next few years. Therefore, with the information we have, it is extrapolated that future expenditure sources will be from:

  • Investment on video content for Facebook’s video platform
  • Investment on content for Oculus VR
  • Fact-checking programmes to maintain ecosystem health
  • Investment on network infrastructure and data centres to support user growth in APAC and Rest of World (RoW) region

Therefore, we expect significant investments on content will have effects on its bottom line and net profit as a share of total revenue may come down in the next two or three years. However, it is still highly probable that Facebook’s revenue growth will outpace its spending on investments and the upbeat of net profit in absolute amount will still continue strong.

Another aspect to take note here is the noticeable disparity between major user growth coming from APAC region and developing nations and major advertising revenue coming from advertisers in the U.S, Canada and Europe. This is shown in the ARPU of Facebook in its Q1 2018 report.

Image result for facebook arpu 2018 q1

Hence, the main point here is that total ad revenue growth by U.S and Canada users must exceeds the total expenses of serving APAC and RoW users. In this research entity’s opinion, this is not something to worry about, just something to take note. Also, because excessive ads displayed to user will harm user sentiment, Facebook must roll out innovative ad products and diversify their products pipeline so that user sentiment won’t be harmed.

There are also two industry-wide factors affecting Facebook’s revenue: a broad trend of revenue shift to digital advertising (tailwind) and an economic recession (headwind). An economic recession is highly likely to hit the U.S economy in the future few years and it will definitely hampers Facebook’s profits. However, that is also a great opportunity for investors to cash in Facebook’s stock at a great price

Overall, in the course of the next few years, there will certainly be new products and new features that will be announced. Changes will occur and hurdles will be met. Therefore, what we are betting on is primarily Facebook’s management to overcome hindrances and their ability to continuously come up with great products and features to maintain their user platform dominance and ad revenue growth 

Valuation

I would like to apologise here for my inability to come up with a detailed valuation model based on numbers and figures, due to my lack of knowledge in valuation modelling. Therefore, take my fair value of Facebook with a huge grain of salt and find more believable people to reach a better conclusion on its appropriate buying price.

Because of my deficiencies, I decided to determine whether the current price ($200 per share) is a fair price for Facebook based on market participants’ anticipation and assumptions about Facebook Inc. After scanning through many analyst reports and market opinions, my conclusion is that Facebook is slightly overvalued and that market participants have held very high expectations on its financial performances, leaving little margin of error for things to go wrong. Although it is likely that Facebook will be able to hit their expectations if everything goes right and if the economic condition is in good shape, we don’t feel comfortable with its thin margin of safety (in terms of market expectations).

Furthermore, we believe that over the next 2 – 3 years, there will be better buying opportunities and the probability of a recession coming largely increases. Therefore, we believe that now is not the best time to buy Facebook stocks, and thinks that our patience will promise us great opportunities. In conclusion, we believe that the price range of $170 and below will an acceptable price.


And that’s the end of my research. Thank you for taking such a long time to read my analysis on Facebook Inc. I would like to apologise again for the many incompetences and deficiencies in this piece of analysis, I strive to address these shortcomings in my future investment analysis. Also, I will publish my reflections and post-mortem review shortly after this as i think that my mistakes and weaknesses can provide useful insights and thoughts to others seeking to perfect their investment analysis process. If you have any thoughts and opinions about this research piece, you can email yiyangchuah321@gmail.com to discuss your ideas with me. Once again, thank you for your precious time and patience 🙂


Central Assumptions:

Critical mass numbers unknown – thus estimated to be 10% of users (conservative)

Although Instagram is already fairly penetrated in the U.S, Canada and western countries, we can still expect to see it enjoying decent growth in Asia Pacific region and other countries in the world

The law of Divine Discontent exists in the social network industry

Oculus VR will remain immaterial to Facebook’s bottom line and stock performance in the next 5 years, given its importance in Facebook’s long-term roadmap

WhatsApp and Messenger presents limited monetisation opportunities over the next five years

Obtaining user consent to access data won’t be an issue in the future due to user ignorance in the near term and user laziness in the longer term

Facebook is able to battle specialisation and fragmentation by acquiring potential threats and copying rival’s features

VR technology will not mature and will only bring in immaterial growth to Facebook Inc in the nest five years.

Mark Zuckerberg will exercise his voting power prudently and make decisions that are best to the company and the shareholders (aligned incentives)

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Less Complexity, More Simplicity

Have you ever had the experience of trying to solve math problems using sophisticated methods, only to end up realising that the solution can be solved by using simple algebra ?

Most of us thought that doing more results in better outcomes, but there’s a huge misunderstanding in this. In fact, I am writing this post to challenge this statement and present my view that most of the times, we can gain more by doing less.

All things being equal, the simplest solution tends to be the best one – William of Ockham

One of the greatest problem-solving principles of all time is laid out by the great philosopher, William of Ockham several hundred years ago, now popularly known as Occam’s Razor.

I’ve always been an avid reader of the Farnam Street blog, a fascinating blog which has been consistently generating sensible ideas about better decision-making and also mental models from various disciplines that can be applied to our day-to-day lives. Last week, Farnam Street wrote an excellent post about the marvels of making everything as simple as possible (but no simpler!) and gives out explanation about how our tendency to make matter complex can cause problems in our life, including stymied communication, deplorable decisions and wasting our precious time. I feel that the beauty of simplicity also applies to many fields and aspects in our lives, which has not been appreciated by most of the people. Therefore, it’s worth writing a post specifically to highlight how simplicity benefits us in ways that we never have thought of before.

In Investing

In a renowned experiment, scientist and prognosticators set to determine the viability of simple models versus complex models in weather forecasting. The simple weather forecasting model comprises of only three or four variables critical for making astute predictions, for instance air pressure, temperature and air density. The complex model tries to predict the future weather condition by taking complicated variables and mathematical tools into account, such as Monte Carlo simulations and multiple regression analysis. The outcome of the experiment shows that the simple model ousted the complex model by 35% in accuracy.

As a matter of fact, the success of the simple weather prediction model mentioned above owes a great deal to the minimal number of variables it has to control. As the complex weather forecasting model has so many more variables involved to make its judgement about the future weather condition, the probability of committing errors in the input of variables is also substantially higher than those of the simple model. Similarly, in investing, the more variables you need to plug in to your financial models or valuation models, the more forecasts and predictions you need to make to feed numbers into your models. Unfortunately, neither the future interest rates, the future oil price nor the future inflation rate is predictable, because of the dynamic nature of the stock market, and thus making the occurrence of black swans highly likely in the market. To add salt to injury, a mistake in an input of your financial model will amplify the rate of errors in the other variables of the model (because they are interconnected) , forming a sort of domino effect, at last rendering your model futile.

You can see that the change in interest rates and stock market fluctuations never seem to bother Buffett and Munger. Two reasons. Primo, they know that the future is  fundamentally unpredictable. Secondo, they don’t have to worry about it. Why? That’s precisely because they have a much longer time horizon than 90% of the investors in the stock market. To make things clear, possessing a long-term view of buying stocks allows them to trim many variables that are needed in the short-term, in turn lowering their chances of committing errors in their decision. Take the airline industry for example, interest rates matter a lot to airline companies in the short term as the cost of borrowing to fund expansions and buy aircrafts will influence the net income of the company in the next few quarters or one or two years. However, when we contemplate the airline business in a long term perspective, things change. Interest rates doesn’t matter as much as they do in the short term as the feasibility of its business model and efficiency of company’s management is the critical factor which determines the success of the company in the subsequent 20 years. Viewing the action of buying stocks as holding a business for years gives Buffett and Co the privilege to keep things simple and sidestep potential mistakes. That’s why I’ve always advocated holding to stocks for a medium-long period.

In Organisations

Most of the you may have listened to this joke before:

Person 1 to Person 2: Oh My God! I just hurt my ankle this morning.

Person 2 to Person 3: Oh My God! XXX [Person 1’s name] just broke his leg this morning.

Person 3 to Person 4: XXX just got his legs amputated this morning.

Person 4 shouted: XXX is dying soon!

Ok, the joke is of course presented in an exaggerated manner. However, the lesson and warning it gives us is timeless, and organisations should always keep this cautionary tale in mind. An overly complex hierarchical company structure will do more harm than good to a company. As the levels of hierarchy in an organisation increase, miscommunication problems arises and efficiency in communication will also decline steadily. While it seems like a tiny thorn in the flesh in the beginning, the negative effect of inefficient communication is insidious and it may bring a company down to its knees anytime.

Outside threats from competitors, cracks in product line, growing customer dissatisfaction, all these aspects that are fatal to the company are most commonly discovered first by the grassroots level in the company, i.e: salesperson and customer service employees. However, a complex hierarchical organisation structure makes it difficult for grassroots to express their concern to the management of the company as they have to go through so many levels and obstacles to convey their message to top-level management. The entire process is extremely painstaking and cumbersome, disincentivising employees to share their ideas. When executives realise that there is a huge hole in the boat allowing water to flow in and sunk the boat, it’s often too late.

Keeping the communication process as simple as it can be is more useful that you think, potentially saving your company from bankruptcy.

The Commander’s Intent

In the book Made To Stick, Dan and Chip Heath introduced a concept popularised in the military known as the “Commander’s Intent” that can guide employees to make judicious decisions under any circumstances that is aligned with the company’s core value. An excerpt from the book provides a concrete example how the Commander’s Intent can be applied to the business world:

Southwest Airlines is one of the most successful budget airlines operating in the world today. In fact, Southwest has been consistently profitable for more than thirty years.

The secret to their success? Cutting unnecessary expenses. And they’ve been doing it for decades.

In order for them to succeed at such a high level, they must coordinate with over 45 thousand employees, from their pilots to their baggage handlers. They achieve this by using a “Commander’s Intent”, a core principle, that helps guide this coordination.

The Commander’s Intent is a simple, no-nonsense statement that appears at the top of every order, specifying the plan’s goal and the desired outcome of an operation.

During an interview, Southwest Airline’s CEO, Herb Kelleher once said that I can teach you the secret to running this airline in 30 seconds. This is it: We are THE low-fare airline. Once you understand that fact, you can make any decision about this company’s future as well as I can.

Tracey, from marketing, comes into your office. She says her surveys indicate that the passengers might enjoy a light entrée on the Houston to Las Vegas flight. All we offer is peanuts, and she thinks a nice chicken Caesar salad would be popular. ‘What do you say?’

You say ‘Tracey, will adding the chicken Caesar salad make us THE low-fare airline from Houston to Las Vegas? Because if it doesn’t help us become the unchallenged low-fare airline, we’re not serving any damn chicken salad’.

Many corporations like to list out an array of mission statements and require every employee to comply to those statements whenever they are executing their tasks. While the reality is, nobody will gives a sh*t about those lengthy and dull principles while doing their job. Instead of laying out countless mission statements, emphasize on a simple statement, a Commander’s Intent, that can be the ultimate principle to refer to while making tough decisions.

In Designing

Incontrovertibly, It is a fact that flat design is the mainstream in user interface design since 2014 to date. It is ubiquitous – especially on Windows and Android,  the most used desktop and mobile operating systems respectively. It doesn’t take you a whole lot of observation to realise that the app icons of the IOS system has went from three-dimensional buttons and textured backgrounds to relatively simple icons and clean, very readable text. A stark comparison can be seen below :

Image result for ios 6

A large part of the success of flat design can be attributed to its minimalistic design and not overcomplicating design. As the webpage design company, CommonPlaces has stated in its blog:

” The idea of Flat Design came from focusing more on usability, and less on familiarity. The philosophy is that our minds don’t need complex visual cues to understand what we are looking at. We are perfectly capable of recognising shapes and giving them meaning with minimal cues. “

In fact, overcomplicating user interface design causes unnecessary distractions that otherwise have no definitive purpose, and may only distract us from the purpose of the application. The central concept of minimalistic design is to let out brain do the interpretation work and concentrate solely on simple imagery to make icons easily understandable, while being a very simple way of adding hierarchy.

In Life

Most of the time, we make our lives more complicated than it ought to be. For your information, Bhutan is a country in Southeast Asia that is just south of China. The country is known for being really small and for being really happy. They are widely known to be the happiest people in the world.

How do they achieve this remarkable feat? That’s precisely because the minutiae in life is sufficient to make their day full of joy and ecstasy. They focus not on the the materials that they don’t have, they focus on what they already have. They don’t care whether they have ultra-fast internet speed, high resolution 4K TVs or a brand-new Iphone X. They feel thankful and fortunate because they are born in a nation which is free from catastrophes and a picturesque living environment.

Many in our society ask for countless things: they want a huge base of Instagram followers, a romantic relationship, an impeccable body shape, a healthy life, a successful business, a lucrative payslip …… The list goes on. Life do not burn us out, we burn ourselves out. I would like to clarify that I’m not discouraging any of you to stop improving yourself, I’ve always hold the view that constant learning and constant self-development is a moral obligation for everyone. In this context, I am trying to tell you that while you are on your journey to pursuing your dreams and what you want, you should always stop for a brief moment, turn your head back, and look at the trivial details in life that excites you, look at the people who have loved you and given you support. Through this, you will find that life, is so wonderful, and thank god that you grow up in such an environment.

A little piece of advice I give to all of you in order to appreciate your life more and increase your personal happiness level is to write a journal everyday. Try to write a thing or two that excites you or make you smile everyday. In the long run, you can see that there are so many things that can make your life filled with joy, and the outcomes in life doesn’t matter as much anymore, the essence of life lies in the process 🙂

How to learn from your mistakes

“Make mistakes, learn from them, move on”

“Don’t waste a good mistake, learn from it”

“Those who cannot remember the past are condemned to repeat it”

I think that’s enough of it. Since we grow up till we climb the ladder of society, our parents, teachers, and many successful life-achievers have given us the advice to “learn from our past mistakes”. It is a down-to-Earth piece of advice: learning from mistakes allows us to overcome hurdles that stymie our progress in the past and enables us to adapt better to changes in today’s ever-changing society. The pioneers of our time, such as Steve Jobs, one of the brightest mind in investing, Ray Dalio, and Nobel-prize winning psychologist, Daniel Kahneman all share the traits of recovering from failures rapidly, and come back even stronger.

With this in mind, let’s be honest to ourselves: After hearing these quotes for so many times, how many times have we really managed to completely avoid ourselves from committing to the same mistakes again and eliminate bad habits that we used to possess?

If your answer is none, don’t worry, you are just like most of the people out there. Many of us took a long time, even years, just to recognise their mistakes. The fact that everyone tries to tell us the importance of learning from our own mistakes but not teaching us the way to correct ourselves make it so difficult for us to react to our mistakes efficiently. Fortunately, there are some tricks and solutions to address this ‘repeat-our-mistakes’ situation. The first step is of course to recognise your mistakes in an early stage right after you made a mistake

The willingness to find out mistakes

Many of us took ages just to recognise our mistakes because of the way how we view  mistakes and failures. We’re taught in school, in our families, or at work to feel guilty about failure and making mistakes is a shameful thing. An implied value in many cultures is that our work represents us: if you fail a test, then you are a failure. If you make a mistake then you are a mistake. Therefore, we dreaded mistakes. We will bend over backwards and go out of our way just to prove that we’re not wrong. Most people are willing to go that far and even cheat on themselves. To them, failures are too painful to bear, so the simplest way is to just distort reality so that they do not have to face the harsh truth.

Hence, we must change our traditional perception about mistakes and failures, so that we can get out of our comfort zone and stand up to the mistakes you’ve made. The famous Chinese proverb sums it up:

“Failure is the root of success”

Without failures and mistakes, there’s no way we are going to attain our goals in life, work, and relationship. Repeating the old mistakes we’ve done is shameful, but erring is not. On top of that, we should view mistakes as a golden opportunity for us to become wiser and better positioned to face uncertainties in the future. Once we view mistakes as a norm and are willing to open our heart to them, learning from mistakes is not that hard a thing anymore.

Identifying our Real mistakes

The next step to finding out our mistake is to expose our ideas and opinions to our peers or the public so that we can receive feedback from outsiders and get a more holistic view. The reason why exposure to the outside world is so crucial is because if we keep the idea to ourselves and never share it with other people, we will be biased to think that our idea or product is perfect and overestimate the feasibility of it (This situation is coined with the term ‘overconfidence bias’). For instance, if you keep dedicate your time to working on a flying car project in your own garage and never let it appear in the public’s sight, how would you know if people really like flying cars ?

Once we gain exposure and critical feedback from our peers, the public or the market, there comes the critical part: spotting possible mistakes from the feedback we received. The substantial quality that differentiates competent individuals from the crowd is their ability to adapt to feedbacks efficiently and recognising potential mistakes and blunders that may hinder their progress in the future. The only problem that lies in this method of detecting mistakes is that the mistake detected may be only the ‘surface’ and not the underlying mistake (root cause). This is where the 5-WHY analysis model comes into play.

The 5 Whys technique was developed and fine-tuned within the Toyota Motor Corporation as a critical component of its problem-solving training. It is a simple and straightforward analysis to discover the root cause of a problem by asking yourself ‘Why?’ on a particular question for five times. This explanation may be kind of abstract and I think a concrete example will do good. Consider the situation below:

A robot you’ve built has just broke down

Using the 5-WHYs technique:

Toyota 5 whys example

Aha! We then know that the underlying problem lies on the filter of the pump! Of course, this technique can not only be applied to engineering, but also in tracing mistakes we’ve committed in our decisions. Thus, after receiving feedbacks and using the 5-WHYs technique to find out our underlying mistake, all that is left to do is to refine ourselves and fine-tune our mistakes.

Please always keep in mind that mistakes aren’t meant to be shameful, they’re meant for self-improvement. As soon as you start blaming other people (or the universe itself), you distance yourself from any possible lesson. However, if  if you courageously stand up and honestly say “This is my mistake and I am responsible” the possibilities for learning will move towards you. Admission of a mistake, even if only privately to yourself, makes learning possible by moving the focus away from blame assignment and towards understanding.  Even wise people admit their mistakes, so why shouldn’t you ?

 

High Output Brainstorming

Gathering your team together for a group discussion and collectively generate new ideas to solve problems that you and your team are currently facing, doesn’t that sounds like a fantastic method to come up with wonderful solutions? The idea of overcoming problems and coming up with ideas together has already existed since the ancient times. Many old wise sayings (e.g. ‘Many hands make light work’ , ”collective wisdom reaps wide benefits”) also stress the importance of discussing opinions and making decisions together. With all of these in mind, brainstorming session seems like the best way to conduct the problem-solving process, and that’s why brainstorming session is the favourite of most of the crowd. However, there’s normally a huge gap between imagination and reality

                       Imagination                                                     

corporate-brainstorming-session

 

 

 

 

 

                        Reality

Meeting boredom

 

 

 

 

 

A picture speaks a thousand words 🙂

The brainstorming session literally turns into a low-efficiency sleeping room whenever it is hosted. Should we just bash brainstorming sessions ever since and think of problems individually rather than collectively? I believe the answer is nope. Although the brainstorming session has many of its shortcomings, I believe it can still remain as a powerful tool for groups to engage problem-solving. Alas! the concept of brainstorming itself is a brilliant and insightful one, no doubts on that. It is the way how typical brainstorming sessions are usually conducted and the details in the entire brainstorming process that makes it horrible. The book Getting To Yes, by Roger Fisher, has given me unique insights on overcoming the brainstorming dilemma and formulating a set of brainstorming procedure and guidelines which can make high output brainstorming possible, as below.

Prior to the brainstorming session:

  • Call the group for a short-and-sweet meeting to brief them about the problem that the group is facing and needs to be discussed in the session (brainstorming objective). This meeting should only take about 10 -15 minutes as it is only a summary of the oncoming brainstorming session.
  • The meeting is adjourned and everyone in the group is required to come up with at least 3 solutions in respect to the problem in the oncoming brainstorming session.

Brainstorming


 1. choose a group member as the brainstorming facilitator

 The role of the facilitator is to: host the meeting, clarify the situation when one of the   group member is making an unclear statement, jot down important ideas on a whiteboard (if there is one) and control the tempo and rhythm of the session

 2. Every group members should then come up with their ideas.

 In the session of the group members listing out their ideas, criticism of ideas are not  allowed until all group members finish proposing their ideas. This helps to shape a  healthy and creative ambience so that group members will be more open and  encouraged to come up with wild ideas (that seems absurd at first thought but actually make sense!).

 3. Stimulation of more ideas and criticism of ideas

 After everyone was done proposing their solutions, the process of criticising ideas can then take place. It is advised for the facilitator to remind all group members that criticism of ideas should be expressed in a polite and not-so-aggresive manner to prevent any unwanted conflicts. When things are heating up, the facilitator should also intervene to keep the situation under control.

 4. Subtraction of ideas

 The weaker ideas will naturally be ousted following rounds of criticism of ideas and discussion

5. Coming up with the best ideas

The best and preferred solution to address the problem is chosen after listing the pros  and cons of each one. One or two best alternatives to the preferred solution will also be taken into consideration.

 

Ta-da! An efficient brainstorming session should be one that is as simpler as it can be, but no simpler. I still have some thoughts and advice regarding the brainstorming session:

  • The brainstorming should be done within a time frame of 90 minutes (according to my experience, long sessions will only make the process duller and productivity will only decrease over time). If the session really can’t be done within 2 hours, try to host another brainstorming session the following day with a refreshed mind

 

  • A semi-circular meeting table is the ideal conference table. Several psychological studies have found that round tables creates an atmosphere of relaxation and add a sense of harmony to the meeting room

CFCC1

  • A sensible incentive system can be tailored in a way that rewards the entire group to encourage group members to come up with better ideas and make better, rational decisions. However, it must be noted that one must be very careful in designing such an incentive system as a poorly-designed incentive system can lead to skewed incentives of group members and mess up the brainstorming session. I will not further elaborate on the details of creating an incentive system here.

 

I hope my insights on brainstorming can help you all who are reading this memo host a much productive brainstorming session and produce high quality works that will benefit the society.

Yang

P.S: I will not be posting any content for the next few months probably until December because of my oncoming trial exam and national exam (which is extremely important to me!). Good luck to all of you in your future too.

Stop checking stock quotes everyday from this moment on

Do you still remember the very first time you bought a stock? I still do. The feelings that were contained within me at that moment I use my father’s trading account to execute my virgin trade was, inexpressible. It was a barometer of emotions which includes sheer excitement, enthusiasm, happiness and, of course, a sense of anxiety, fearing that your first investment will end up in the red. Under such a plethora of emotions, I can’t stand the urge to check the stock prices and stock news on Yahoo Finance everyday. I sat in front of my desktop everyday before the market opens, and stare at the movement of the stock charts. My heart was thumping at the same rate of how fast the stock price was changing. I believe I am not the only one here. Any investor will have a similar experience when they first start know how to trade.

However, it’s not a good news if you still carry this habit with you after years of stock-investing experience. There’s a high probability that you are earning significantly less money than your peers in the stock market. Statistics and researches have shown that investors that monitor company news and stock price everyday tend to make 53% less profit than investors who check the company news and stock price once a month. This fact may come as a shock to some of you, as monitoring stock quotes and company news frequently doesn’t seem to be the culprit of your poor investment performance. Hence, I think it’s worth it to delve deep into the cause-and-effect relationship between the two matter discussed above.

First and foremost, please keep in mind that it’s virtually impossible for you to eliminate your emotions when you are focusing on the stock price every moment. In fact, ‘negative emotions’ like anxiety, greed, and fear will spread like wildfire the more frequently you check your stock quotes, and to put it in another way using Buffett’s quote:

“Fear and greed is the foe of the faddist”

When fear and greed is acting on us, they will crush our analytical reasoning skill and rationality. This is because we have already drained most of our brain power and mental energy while worrying about how the stock price is doing every now and then, we are too exhausted to evaluate the attractiveness of an investment properly with deliberate thinking. Consequently, we substitute System 2 thinking with System 1 thinking to make decisions with intuition rather than logical reasoning. That often leads to very, very bad decisions and eventually poor investment record.

Secondo, most of us are prone to take more action than we used to if we constantly check on company news and stock prices, which will trigger the do-something bias. Short term fluctuations in the stock prices should be a noise that you are supposed to ignore, but you can’t stand the itch to do something when you keep on absorbing new information on the company’s feed and share price. Therefore, you start reacting to every small portfolio fluctuations and churn your portfolio regularly, even though most often the best decision is just to do nothing. On one hand, frequent portfolio rotations violates the principles of Occam’s Razor, which by its logic states that less decisions = less errors. On the other hand, the meagre trading cost incurred in every trade will add up to a significant expense that can’t be ignored as it erodes our investment return.

Alas! Many investors still have the misconception that constantly updating themselves with the latest company news is a key step to make better investment decisions. It’s sad when the true fact is that doing so will only drag you down into the ‘information overload’ quagmire. Quoting you an example, let us take a look at the ‘latest news’ of Disney corporation.

Screen Shot 2017-06-26 at 11.38.33 PM

It’s not that hard to notice that most of the recent news covered are either analyst opinions (which hardly count as an useful information from the company itself) or unimportant little matter that is irrelevant. Failing to discover how inefficient it is, we would have wasted a large amount of time seeking for low-quality information and reinforces us to think with a short-term lens. Garbage in, garbage out. It’s no wonder that we always make poor decisions when we shape our investment thesis on information and inputs that doesn’t have huge influence over the company’s future position in the long run. Poor investment record turns out to be the perfectly reasonable outcome in this scenario.\

I don’t care how you are going to make it and what way are you going use, just stop checking on company news and stock prices every moment if you ever care about succeeding in investing. I’ve been there and done that, so do many others that I’ve witnessed in my life. It’s insidious, and you may not know why are you failing in the stock market until you came across this short memo. I merely hope my advice and perspective can help you pull yourself out from this dreading habit.

I would like to end this note with an amazing quote which I stumbled upon recently.

“The stock market is a device transferring money from the impatient to the patient”  – Warren E Buffett

How to be lucky in your life

Luck is one of the things that can be obtained by literally everyone on this world, yet so many complained about their misfortune in life. In fact, I am actually shocked when I get to know that so many people tend to think that luck was unattainable in life. Today, I am going to share some of my perspectives on luck and how we can substantially improve our luck in life.

SONY DSC

1. Think positively

The first step to have a lucky life is to think positively about things that happen in your life. Think about it, how can we possess luck when all that is stuffed in our mind is negativity? Imagine this scenario: You are fired by the company which you have worked 20 years in it because of an economic recession. Your subordinates which is in many ways less competent than you, just took over your position. You’ve lost your bread and butter overnight, you still have three kids to raise and your mortgage loan to pay. You can choose to lock yourself in the bedroom and complain about your misfortune all day long, or sit down and think of what to do at this moment to overcome this hardship together with your family. One thing that can be certain is that the sticky situation that you are facing isn’t going to change. Instead of complaining like an immature boy, why don’t you position yourself optimistically and view this as an opportunity for you to rethink about who you are and a chance to pursue your dreams? God always leave many doors opened when he shut one of your window.

2. Surround yourself with positive people

Since we want as many positivity as possible in our lives, we should always surround ourself with positive people, people that can make our lives happy (In fact, many studies show that our happiness is directly proportional to luck as we perceived in our lives). There is always a saying, ” Tell me five of your closest friends and I’ll show you what kind of a person you are ”. Negativity is contagious; it can be spread through words and actions in your everyday life bit by bit. Hence, the easiest and time-saving way to improve your luck is to expose yourself to optimistic peers. You may even start to think of how lucky you are to come across those people in your life !

3. Pursue knowledge and observe things

Knowledge is power. Knowledge is also the source of luckiness. Many people may wonder, what does knowledge have to do with luck in our lives? This question can be easily answered by throwing out more questions such as: Is Jeff Bezos lucky to catch on the rapid development of the Internet when he build Amazon? Is Warren Buffett lucky to build his wealth in the stock market when the American stock market is in its golden era? Is Bill Gates lucky because his mother is on the board of director of IBM and this leads Microsoft to get the contract for the operating system, which eventually makes Windows the default operating system of every PC?

The opportunity is there for everyone, Jeff Bezos isn’t the only one to be there when the Internet is growing rapidly and millions of people grow up in the same era as Buffett in the same country. Why only few of the population saw what was coming? Are the rest of them truly unlucky? No, it was because they simply do not contemplate what was happening around them. The depth of their thinking and knowledge render them unable to capitalize on the opportunities that they are given. Every ‘lucky’ guy is ready to act on the chance they are given and that is what makes them ‘lucky’. Knowledge enables them to discover chances around them and gives them the ability to tackle on these life-changing opportunities. There is no way Bill Gates will be offered the operating system contract by IBM if he doesn’t have a sensible business plan and impressive business acumen. The source of his luck comes from his ability and his ability comes form accumulating knowledge and constant learning.

Set you goal to be a little wiser everyday, because that means being a little luckier everyday.

4.  Treat others kindly

One of the by-products of treating other people well is being able to gain more luck in your life. Little pleasant actions such as offering your seat to an old lady in the bus, buying breakfast for homeless and sharing your happiness with your colleagues in your everyday life will establish you as a ‘positive person’ in other people’s mind. Remember the old axiom “If you treat people well, people will treat you well” ? It is highly likely that people around you will go out of their way to support you when you are facing downturns in your life if you be kind to everybody. Their support will make the initially depressing situation less deplorable and unexpectedly turn it into only a small problem for you. Besides, people will be willing to share their knowledge and insights with you, they would’ve also thought of involving you when they come across a rare opportunity that will benefit both of you. This can turn out to be the greatest source of luck in your life.

5. Visualise success

How well do you think you will perform on a date, job interview, or sporting event if your thoughts are filled with reasons you will fail? The odds would not be in your favor. The best athletes see themselves winning a game long before it starts. The best stage actors imagine an audience exploding with laughter and applause before they set foot on stage. If you’re going to a job interview, imagine how thoughtful your responses will be during your drive. If you’re preparing for a date, imagine how classy / handsome / sexy / funny the other person will find you while you get dressed. You must first see success happen before you can make it happen.

I think most of you have probably realised that all these steps above aren’t any big secrets. Everyone knows it and they are not that hard to implement, yet many still fail to realise that luck is already on your side. Being able to carry out day-to-day activities without difficulties, being able to see your parents everyday, being able to read this post comfortably at home.

Having a normal day is perhaps one of the best thing that happen to us 🙂

shsh

Idea generation in investing

I still remember that moment three years ago, when I was still a novice investor reading Berkshire Hathaway’s annual report with full of excitement and enthusiasm, I was clearly amazed by the spectacular returns of Buffett and Munger over the last 50 years in the stock market. Their early investment in well-known companies nowadays such as GEICO, See’s candy and Coca-Cola are investment classics that should be included in the textbooks in business schools. Nevertheless, what I was wondering at that moment was: How did Buffet manage to unearth those hidden treasure when they are still relatively small and was not in the public limelight? Are good investment ideas that easy to stumble upon? Definitely not. After three years of experience in the stock market and accumulation of knowledge, I finally have some answers for the question I’d asked myself three years ago. My idea generation process often takes place in four forms.

1. Screening

Screening softwares and services are provided by various financial data and software companies such as Bloomberg Terminal, Capital IQ and Factset. For individuals that may not want to spend such a hefty amount on financial softwares, there are also many stock screening tools on the web offered by Morningstar and Yahoo Finance. Most importantly, it’s free! Screens enable us to filter stocks based on different metrics such as a minimum Return on Invested Capital, Debt to Equity Ratio and the free cash flow of the company. Stock screening definitely does a great job in helping us to weed out those stocks that don’t meet our requirements and focus on the instruments that are within the user-defined metrics. However, it is not enough to discover great companies that can last for many years merely by picking stocks based on the results of our screening process. We must have the ability to see the big picture from the numbers that are screened. For example, a higher than average debt-to-equity ratio doesn’t implies that the company is a rotten apple. It may indicates that the company needs massive capital to fund its growth and expand market share. It might have a bright future ahead of it, making it the next Google or Amazon. Likewise, a low debt-to-equity ratio doesn’t make a company a ‘quality-guaranteed’ company. On the other hand, investors should have additional filters to really get down to something interesting from a long list of companies that appear on the screen. The filter includes qualities and traits that should exist in a well-managed company such as candid management, healthy cash flow and a healthy amount of debt. There are too many qualities in a company that should be taken into consideration so I will not list them out one by one here. (That would probably cost my entire school holiday!). In short, stock screening is a very useful tool to generate ideas in a short time span but it must be used judiciously, coupled with your own analysis and filters.

2. Other investors

You can get some fantastic ideas from other investors occasionally, ranging from institutional investors such as David Einhorn and David Tepper in investment conferences, to people around you which share the same passion towards investing with you. For me, my friends and pals are still concentrating in their video games and social network. Hence, my only source of investment ideas from people are my father and professional investors that share their ideas. I feel the need and commitment here to make a point that getting ideas from your friends and other people doesn’t mean that you should buy in their idea and just follow their decision without doing any due diligence and thinking. This will only make you invest like a headless chicken and end up in red. What you should do is trying to understand the underlying reason of their decisions, their investment analysis process and think of disconfirming evidence to challenge their view. If after you did your research and analysis to come to a conclusion that the particular company is an attractive one, then congratulations! you earned yourself a great company from other people. However, if you think that the company is overvalued and thus not worth investing, at least you get to improve your thought process and obtain a different perspective from the others. This is a heads-I-win, tail-I-win situation!

3. Look and Observe

I began reading about Peter Lynch and his investment concepts before I really began studying Buffett. His common sense approach stroke me hard and I still think that it is a really great approach to find out interesting ideas that are not known by anyone. Looking and observing at the things that is happening around the world is one of the best investment I could’ve ever made. You will soon start to realise that many of the things around us pretty much contributes to an investment idea. I never like to go the market with my mother because I’ll need to wake up really early. One morning my mother dragged me out of bed and without any other choice, I would need to follow her to the morning market. While my mother was buying eggs, she was complaining about the sky-rocketing egg price recently. Two months later, the largest egg company in Malaysia, Teo Seng announced its earnings, with profit exceeding the consensus by a large margin. Since then, I was always prepared to wake up early and follow my mother to the market. Quoting another example from the book One Up on Wall Street, Peter Lynch has always bought his children Disney films and toys and his children were never tired of watching them over and over again. The rest is history. He still regretted missing this huge opportunity until today. However, the quote ‘Invest in What You Know’ made popular by Peter Lynch is being misunderstood by the public. Some 25 years after his retirement from running Magellan Fund, Mr. Lynch clarifies that he never said, ‘If you go to a mall, see a Starbucks and say it’s good coffee, you should call Fidelity brokerage and buy the stock,’ ”. 

Every investor should keep in mind that however good is the product of the company or however confident your friend seems when he recommend an idea to you, you should conduct enough due diligence and analysis before making your investment in a company. Never let the herd guide your thinking and don’t let their mind make decisions for you. As Mr.Buffet would have put it,

“Don’t think of buying stocks, think of buying businesses”

 

What Every 20 Year Old Should Know

During the filming of #AskGaryVee Show 244, Taylor, a 22 year old fresh out of college, phoned in for advice on how she can build a business. What followed was one of the most important pieces of advice I have recorded and is applicable to almost all my community, but definitely to young people across the world between 20–30 years old.

(I apologize for not being able to embed the entire video here due to the constraints of my free wordpress plan)

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Source: Google Images

This conversation really struck a chord with me. Although maybe some of you have already received similar advice from your parents, I strongly recommend everyone in their teens to just spend 15 minutes and listen to this thought-provoking conversation. The advice offered by Gary Vaynerchuk, one of the most successful serial entrepreneur in the world. Here is a topic from the conversation that I thought were worth bringing out:

Key Takeaway : Action

I believe that most of the teenagers today, at the age of about 20 – 30 years old, will more or less face this problem: Seeing other teenagers enjoying huge success while you are still here, lying on your bed endlessly scrolling through your Instagram. Phew, your entire Sunday was over, and wasted again.

Don’t worry, you are not alone. There are many teenagers out there who are like you and they are also having the same thoughts in mind: Craving for success in their early life, but not knowing where to start from. I have heard of many people saying: “By 26 I am going to make it to the Forbes 30 Under 30 list and become one of the hottest tech entrepreneur in Silicon Valley”, and continue to post videos to their Snapchat story. That is not the way things should be done. This is not the way multi-millions business are built.

I used to be one of you who dream to be a billionaire and go to bed without having produced any ideas or actions everyday. Fortunately, I was struck by a simple thought that changed my life forever when I was 13 year old. One night when I was about to drift into dreamland and start my ‘billionaire dream’ all over again, a voice popped up in my mind, saying: What if you keep dreaming of becoming a billionaire everyday and still hasn’t really done anything at all when you are in your 30s ? It was just a brief idea which came across my mind, but it left a permanent effect on me since that day. I know I definitely must do something.

Thus, i began my journey to find out my interest in life and what am i going to do for the rest of my life to earn me a living (Yes, I am lucky enough to find out my passion for investing at a really young age). The first book I read on investing is The Intelligent Investor, the second is Security Analysis, not knowing what sh*t the author is trying to express (only knowing later that what a brilliant mind Ben Graham was! ). But that is how i get started, and I am grateful I marched out this small step. Today, I’ve already grown a substantial amount of knowledge compared to the 13-year-old me, compounding your knowledge is the fastest way to build your wealth. The more I read, the more I realise how ignorant I am and there are more and more knowledge waiting for me to explored.

Back to the topic, which I believe most of you are eager to ask me now: How do I get started ? How to make my life better from today onwards ?My answer, as always, is to start small. It’s almost impossible for one to lay out a 5 year business plan and start to execute the plan on the following day. Even most of the business titans in the world started small, and eventually grow their business into the behemoth they are today. I have what I called, the ‘Yang pathway’ for those who do not know how to get started and create success in their life.

Yang Pathway:

1. Find out things that you are good at and passionate with

Your life won’t be able if you are going to spend your whole life working on stuff you doesn’t like at all. The best bet to a bright future is to explore things that you will always be willing to thrive in from dusk till dawn.

2. Develop your skills and expertise 

Now that you’ve found your passion and the next thing you are ready to do is to build up your skill set and enhance your knowledge in that particular field.Aim to be the top 1% in the stuff you’re passionate with. To be honest, it’s not going to be easy and it normally take years for someone to achieve mastery in his field. During the process of developing your skills, you may face obstacles and feel that you’ve reach a ‘plateau’. You feel that you can’t keep going anymore, that is the darkest period in your learning phase. But believe me, all you have to do is just climb up every time after you fell. For example, it often take years for a novice investor to develop his investing philosophy and find out which investing style suits him best (especially in such environment when feedback is slow and not concise). That requires not only patience, but great consistency. Having the ‘roly-poly mentality’ is important for you to overcome this hurdle and confront future challenges.

 

Image result for learning curve graph

3. Build a platform to share your knowledge with others / Provide your service to society

Sharing your knowledge and skills with other people is always a joy and also beneficial to yourself because while you’re teaching others what you’ve learnt, you are also reviewing your knowledge at the same time (the Feynman Technique). Say that you are an avid software programmer, and you’ve already mastered multiples programming languages such as Python, Ruby etc. You can develop your own website using your skills and upload lessons or learning tips to the website.

4. Monetise your product

If you manage to grow your website into a community and help users out with the problems they are facing, Congratulations, you are on the right track ! However, a product that can’t bring in any profit still can’t bring you to the place you want to be. This is why the business model is so crucial because it is the key that determines  the success of your product. You can bring in revenue by different business models such as a subscription based business model, freemium and etc. Always review your business model to examine its feasibility and keep your users engaged. Facebook is one of the platform that manage to leverage its enormous user base to bring in lucrative profits. Facebook modularise advertisements by allowing advertisers to target customers directly.

I hope that the ‘Yang Pathway’ can provide all the teens outside a sense of direction in their life and get themselves started. I can’t guarantee it’s useful for everyone but at least it can act as a guide for you when you are lost.

Finally, there’s a quote I think that is worth sharing:

The best investment of all time, is investing in yourself