This earnings reporting season was a brutal one for Facebook and Twitter.

At the close of business on July 25, Facebook and Twitter were up 23% and 84%, respectively, outperforming the S&P 500® Index and the tech-heavy Nasdaq year to date.1 But once both companies reported disappointing quarterly user growth and weak growth projections, market reaction was swift and brutal.

By the close of business two days later, Facebook stock had plunged by nearly 20%, as shown in the chart below.2 Investors sold shares after the social media firm reported revenue and user growth that missed analyst expectations for the latest quarterly earnings season. Facing a heightened focus on data regulation, underscored by Europe implementing strict data laws during the quarter, Facebook guided estimates lower for revenue and user growth throughout the rest of the year.

Twitter stock fell more than 20%.3 While its quarterly earnings and revenue beat expectations, monthly users of the platform dropped by 1 million in the second quarter and user activity is projected to decline further as Twitter attempts to fight spam, fake accounts and hate speech.

As a result, near-term market sentiment for Facebook and Twitter is likely to be skewed to the downside with the potential for elevated volatility as investors digest the companies’ underlying fundamentals. Despite the market’s strongly negative reaction to these earnings announcements and forecasts, we believe long-term growth trends remain intact for the new Communication Services sector, which will include Facebook and Twitter.

Communication Services: Long-term prospects remain intact

In September the Global Industry Classification Standard (GICS®) is upgrading the traditional sector investing landscape. The old Telecommunication Services (Telecom) sector will disappear, and it will re-emerge as the new Communication Services sector. Its profile will be expanded to include companies from Consumer Discretionary and Information Technology, which will add growth to a sector that has traditionally been seen as a value play, and the new sector will reflect massive changes in the way we communicate, interact and consume content.

While the market may have reacted harshly to Facebook and Twitter, the Communication Services sector’s long-term prospects are still attractive. Companies that facilitate how we access information, consume content and communicate with each other stand at the center of the growing segments of the economy in today’s Information Age.

This is reflected in estimates for total media advertising spending worldwide, which is projected to rise 7.4% to $628 billion in 2018.4 Digital media is estimated to account for nearly 50% of the total ad spending by 2020. These trends have propelled performance for this basket of Communication Services securities throughout 2018. If this sector had been in existence since the start of the year, it would have been the top performing sector as of the day before Facebook and Twitter reported quarterly results.5

As of July 26, however, the Communication Services Select Sector Index had a 21% weight to Facebook, which dragged down the index by 4% one day after Facebook’s earnings release. Even with negativity gripping Facebook, the largest stock by market-cap weight in the sector, two-thirds of Communication Services stocks in the sector were still up on the 26th of July.6

And remember, the basket of securities included in the Communication Services sector represents an exposure of quality growth at a reasonable price, given the sector’s above-market earnings growth estimates combined with attractive valuations and less-levered balance sheets.

The Facebook fall: Why to pick sectors over stocks

What we can learn from the sudden plunge of Facebook shares is that it underscores the statement, “Why buy a single stock when you can buy the entire sector?”

As shown in the chart below, historically more stocks in the S&P 500® Index have underperformed their respective sectors by more than 10% than the ones that have outperformed by 10%. This means the odds are not stacked in the stock picker's favor, and investors are more apt to choose a stock that underperforms rather than one that outperforms.

Investing in a sector like Communication Services instead of a single stock like Facebook allows investors the advantage of limiting the impact of single stock risk while also benefitting from the secular trends of a shift to a more digital and interconnected world.

To learn more about the upcoming GICS sector changes and the new Communication Services sector, you can read my earlier posts:

1Bloomberg Finance L.P., as of 7/25/2018.
2Bloomberg Finance L.P., as of 7/27/2018.
3Bloomberg Finance L.P., as of 7/27/2018.
4Global Ad Spending: The eMarketer Forecast for 2018, eMarketer.
5Bloomberg Finance L.P., as of 7/24/2018.
6Bloomberg Finance L.P., as of 7/26/2018.

Definitions

Communication Services Select Sector Index
The Communication Services Select Sector Index includes companies that have been identified as Communication Services companies by the Global Industry Classification Standard (GICS®), including securities of companies from the following industries: diversified telecommunication services; wireless telecommunication services; media; entertainment; and interactive media & services.

Global Industry Classification Standard (GICS)
A financial-industry guide for classifying industries that is used by investors around the world. The GICS structure consists of 11 sectors, 24 industry groups, 68 industries and 157 sub-industries, and Standard & Poor’s (S&P) has categorized all major public companies into the GICS framework.

S&P 500 Index
The S&P 500, or the Standard & Poor’s 500, is an index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices.