The Lollapalooza Effect and the Decibel of its Impact

By Jillian Tauro | Edited by Aman Kayal

As the season approaches, everything you see on your social media feeds will soon be related to the upcoming music festival our country is to host. The term ‘Lollapalooza’ has an immeasurable significance in the world outside of music.

The term “Lollapalooza effect” was first used in a 1995 Harvard speech by Charlie Munger, an American entrepreneur, investor, and business partner of the renowned Warren Buffett. Munger discussed several reasons why people make mistakes in judgement. Since then, it has evolved into another example of investing speak. A lollapalooza effect is nothing but an extreme outcome. Following his examination of the three primary psychology textbooks, Charlie Munger came up with the term. He observed that the well-known psychological tests, such as Stanley Milgram’s experiment on authority prejudice, neglected to take other biases into account.

Applications of Lollapalooza in the real world

The Lollapalooza effect can have both positive and negative impacts, even though it is typically depicted negatively. One enlightening example of the Lollapalooza effect is the Alcoholics Anonymous programme, which, according to Munger, boasts a 50% no-drinking rate in situations where all other social and health-related variables fail to motivate alcohol abusers to quit. Munger praises Alcoholics Anonymous as an innovative programme that makes use of people’s psychological characteristics.

The open auction method, on the other hand, is cited by Munger as a bad illustration of the Lollapalooza effect. He thinks that in this setting, several psychological biases combine and lead people to behave badly. In particular, the psychological concept of “social proof” encourages people to copy the behaviours of others to mirror what they perceive to be acceptable conduct. As a result, during an auction, participants frequently get into bidding wars because that’s what their peers are doing, rather than because they have a strong desire to win the object up for auction or because they have reasoned that their bid is a fair one.

The Lollapalooza effect on Finance

The Lollapalooza effect may also be seen in the financial world, where it can lead to a “herd” mentality among millions of investors who buy one sector or sell another. The deadliest adversary of every investor is this herd mentality. After all, you risk suffering significant losses if you sell when everyone else is selling. Contrarily, if you buy while everyone else is selling, you’ll probably receive great deals on your shares. Therefore, it’s a good idea to consider how various psychological elements can be leading to an illogical reaction in the market before you invest.

Knowing when a Lollapalooza effect might be at work is crucial for investors. A volatile situation can arise when multiple complex events and conflicting motivations come together. Avoiding circumstances that are incredibly difficult to forecast due to the numerous moving parts involved is frequently the key to success as an investor. In other words, you could be better off, avoiding an investment if there is no reliable way to tell whether it is a smart one.

Alignment with shareholders can extend throughout the entire organisation and can be a valuable contribution to creating a successful corporate culture, which can increase business outcomes and shareholder returns which is another illustration of the “lollapalooza effect.” Alignment with shareholders doesn’t just need to stop at the board and executive management level but at all levels.

The Lollapalooza effect on Meta Stock

A tech startup called Meta has a successful business model for online advertising. It has companies like Facebook, Instagram, and WhatsApp that have a monthly user base of over 3.7 billion. Over the past ten years, Meta has established a reputation as one of the safest investment options by growing its revenues from $5 billion to over $100 billion and achieving PAT [Profit After Tax] growth rates of at least 40%. It also became a member of the exclusive FAANG [Facebook, Apple, Amazon, Netflix, Alphabet and Google] club, a group of five powerful stocks that is a staple holding for investors all around the world, and the $1 trillion club.

Understanding the factors that led to such a well-researched stock’s 70–75% collapse (near to a $700 billion decline) in just 15 months is important so that we can lessen the effects of such wealth destruction on our investments. After this collapse, the stock’s 10-year CAGR [Compound annual growth rate] return lagged below the return of the overall market. Due to the rapid rise of digital advertising over the past ten years, Meta increased its revenue on average by 30–40% annually. In just 15 months, the value of Meta has decreased by 70–75%, or almost $700 billion. On Meta stock, this decline has been credited to the Lollapalooza Effect. Extremes in market volatility can occur as an investor’s behaviour and thoughts interact with that of other investors.

The following is an analysis of the variables that could have caused a dramatic decline in business and stock price:

Value Migration:

Digital ads accounted for 65-70% of all advertising spending in 2021. Saturation points for value movement from old segments to the new segment (digital) have been reached. Now, online market growth is anticipated to mimic global advertising growth, which is currently rising at a low, single-digit rate. Given the strong growth and high margins for established firms, digital advertising is a lucrative industry. As a result, there has been an increase in rivalry over the past several years. The emergence of TikTok was the first indication that Meta faced a serious threat to its primary source of income.

Declining Utility:

Corporations that use Meta’s platform to create targeted advertisements are among its clients. The information that Meta’s platform collected when it was used made this possible. Apple recently revised the ecosystem’s data-sharing policy, which hurt Meta in two ways: they were unable to gauge the value of their product, and reduced data availability led to lower production. Meta decided to incubate new businesses that would enhance the core due to the slowdown in the main operation. For both the Family of Apps and Reality Lab businesses, Meta has increased its capital expenditure. As a result, recent quarters’ free cash flow decreased from billions of dollars to millions. In the next ten years, Meta anticipates investing roughly $70-100 billion in novel fields like Meta Verse, where the business strategy and economic prospects are unclear. The business’s capital allocation risk had dramatically increased.

COVID ‘boons’:

Meta benefited from the pandemic in two different ways. One, everyone began employing internet advertisements to reach clients as online commerce became commonplace. Due to lockdowns, there was a second reason why product demand was far higher than service demand. Both of these elements increased Meta’s sales and profit margin. However, after the pandemic, headwinds became tailwinds as life returned to normal.

Capital costs

The cost of capital is rising globally as the era of quantitative easing draws to a close. As a result, the prices of share companies that are still investing are lower. This effect can be observed even in stocks like Tesla and Amazon which also has an impact on the Meta stock indirectly.

To conclude, we can say that it’s crucial to know how much growth and profitability are included in a stock’s pricing investors. Even the best blue-chip companies suffer horribly when a negative change in fundamentals occurs when stocks are priced for perfection with little room for error in terms of valuation. Avoiding a highly valued, widely known stock is a preferable course of action to safeguard us against a disaster like Meta. Even if purchasing would help us avoid protracted periods of underperformance or more severe drawdowns, we still need to make sure we have an appropriate margin of safety in terms of business quality and lower value if we want to achieve favourable investing outcomes over the long run.

References

The ‘Lollapalooza Effect’ on Meta Stock. (2022, December 18). Bharat Times. Retrieved January 10, 2023, from https://news.bharattimes.co.in/the-lollapalooza-effect-on-meta-stock/

The ‘Lollapalooza Effect’ on Meta stock. (2022, December 18). The Hindu. Retrieved January 10, 2023, from https://www.thehindu.com/business/Industry/the-lollapalooza-effect-on-meta-stock/article66275985.ece

Why the ‘lollapalooza effect’ matters for investors – Robert Miller | Livewire. (2020, June 23). Livewire Markets. Retrieved January 10, 2023, from https://www.livewiremarkets.com/wires/remuneration-a-96-year-old-a-music-festival