Tens of billions of dollars have been wiped off the share price of Netflix, and this streaming services firm is not the only Big Tech casualty. Risk management needs to be centre stage for investors.
The plunge in the price of Nexflix stock last week, adding to woes that have taken its price down almost 64 per cent since the start of 2022, is a stark reminder of how investors must consider risk exposures.
This news service caught up late last week with Dr Richard Smith, known in the industry as "The Doctor of Uncertainty." He is the chief executive of the investing tool RiskSmith, and writes the Risk Rituals Newsletter, which offers investors advice on how to be more successful in a risk-based world. Dr Smith is also a regular commentator and his views have been aired on Business Insider, Forbes, CNN Business and other news platforms.
The dramatic collapse of Netflix appears to have caught
some investors off-guard, but should they have been?
No, they should not have been caught off-guard. The same thing happened to FB [Facebook] recently. Big tech has been way overbid because of the herd mentality of investing and because of the easy money programme of the Federal Reserve. NFLX [Netflix] has been delivering terrible reward to risk ratios since early 2022 with price declining and volatility rising. We saw a similar pattern in FB for three months prior to its big breakdown.
Does the situation raise wider implications for the
health of Big Tech more generally?
Absolutely it does. As the cost of money increases, Big Tech’s future earnings become less attractive which will lead to more negative surprises and less forgiveness. Amazon looks like the next most vulnerable big tech company after FB and NFLX. AAPL [Apple Inc] looks the strongest.
What are the portfolio diversification and asset
allocation lessons that wealth managers and private clients take
from all this?
Pay attention to Sharpe and/or Sortino ratios. When an asset fails to deliver rewards for risks, start trimming in the sails. Don’t succumb to anchoring bias. Just because NFLX was $690 in October 2021, doesn’t mean that it’s a bargain at $350 in April 2022. Increasing volatility has a cost. Pay attention to it. (A “Sharpe Ratio” is the average return earned in excess of the risk-free rate per unit of volatility or total risk. The Sortion ratio differentiates harmful volatility from total overall volatility by using the asset's standard deviation of negative portfolio returns – downside deviation – instead of the total standard deviation of portfolio returns.)
Who in particular needs to heed the lessons of the
sell-off? Are risk management systems fit for purpose in this
Everyone needs to heed the lessons of this sell-off in the likes of FB and NFLX. Wiping out $50 billion of shareholder value in 12 hours should not be possible but it’s happening more and more regularly this year. Something is broken and everyone needs to be on high alert. Risk management systems are extremely useful, but they don’t allow you to keep your head in the sand. It’s a time that all investors have to be chopping wood and carrying water.