Alphabet, Facebook Drop as Citi Warns of Ad Growth Slowdown

(Bloomberg) -- Alphabet Inc. and Facebook Inc. tumbled on Monday, leading a broad move lower in internet stocks after Citigroup Inc. warned about the outlook for digital advertising, a key source of revenue for the sector.

The firm downgraded both names to neutral from buy, writing that “caution is in order” for companies that derive revenue from digital advertising. While ad budgets are expected to continue shifting online, growth is likely to decelerate, and “historically, that usually isn’t bullish for multiples,” analyst Jason Bazinet wrote.

Shares of Facebook closed down 4.1% on Monday, their biggest one-day percentage loss since November. Google-parent Alphabet ended down 2.6% in its worst session since March. The S&P 500 Communications Services index fell 1.9% while the Nasdaq 100 Index dropped 2.6%; both indexes also had their biggest one-day drops since March. Tech shares were broadly pressured on Monday by inflation concerns.

Alphabet shares are trading at almost eight times revenue, near their highest in more than a decade, according to data compiled by Bloomberg. Facebook’s price-to-sales multiple is nine, well above the 5.2 ratio for companies in the Nasdaq 100 Stock Index.

Even with the recent decline, the pair are the best performers among the five biggest U.S. technology companies this year. Alphabet is up more than 30%, while Facebook has risen 12%, exceeding Microsoft’s 11% gain. Both Apple and Amazon.com are negative for 2021.

Both reported first-quarter revenue that dwarfed analyst estimates when they reported two weeks ago. Alphabet’s results were supported by a recovery in business categories that had struggled during the pandemic, such as travel and retail. Chief Financial Officer Ruth Porat said the results “reflect elevated consumer activity online and broad-based growth in advertiser revenue,” though the durability of these trends will depend on the pace of the global recovery from Covid-19.

Facebook’s report showed strong demand from retailers and other advertisers, but it reiterated its view that growth could stall in the second half of the year.

Digital ads have seen robust growth over the past two quarters as the pandemic accelerated a shift toward online spending. However, “the sell side has extrapolated the recent strength for the next five years,” a view that seems too optimistic, Citi wrote. The firm expects growth will decelerate in coming quarters, posing a risk to stock multiples.

Read more: Tech Giants Reap Huge Ad Revenue Growth in First Quarter

Among other names in the group, Citi reiterated neutral ratings on both Pinterest Inc. and Twitter Inc, along with a sell rating on Snap Inc. The only digital-ad stock Citi recommends buying is Roku Inc., as “the connected TV market is still nascent.” Shares of Twitter, Snap, and Pinterest all fell on Monday.

With the downgrade, Citi is now the only firm tracked by Bloomberg that doesn’t recommend buying Alphabet. Forty-two firms still have a bullish view on the shares. For Facebook, there are now 49 buy ratings, six holds, and three firms with a negative view on the stock. The average analyst price target points to potential gains of more than 20% for Alphabet, and more than 25% for Facebook.

Last week, Bloomberg Intelligence wrote that ad pricing would remain a tailwind for Facebook this year “due to demand for its ad inventory, while ad-impressions growth could taper slightly amid reopenings.” It added that the social-media company was well-positioned to achieve 30%-plus growth in its core mobile-ad business despite tougher comparisons in the second half of the year.

(Updates to market close and adds detail about Monday’s weakness.)

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