Back in February, everyone was exuberant with anything that resembled social media. In the week prior to Facebook's (FB) much anticipaetd IPO, shares of Zynga (ZNGA), LinkedIn Corporation (LNKD) and Groupon (GRPN) jumped by 26%, 9% and 22%, respectively. These were crazy times and pretty much everyone wanted to join the party.
On February 6th, I recommended that investors stay away from social media stocks. I explained why investing in these companies will eventually lead to financial ruin. Specifically, I wrote that -
"It seems that based on any metric we might choose, all of those companies are more expensive than expensive. In fact, even if their respective prices had been cut in half, I still would not have touched them with a stick."
Social media stocks - the aftermath
Sometimes one picture is worth a thousand words. Take a look at the chart below to see what has happened in the course of the past ten months to a few leading social media stocks. The line colors are as follows: The orange line represents the benchmark SPDR 500 (SPY), Zynga (blue line), Facebook (green line), LinkedIn (red line) and Groupon (purple line).
Since February, the share price of FB was cut by 40% while shares of Zynga and Groupon simply evaporated 75% of investor's capital. Such an enormous loss is extremely difficult to recuperate. The exception to the rule was LinkedIn, the proprietary job search Internet platform, that not only escaped the suffering of its peers but also managed to increase by approximately 50% during that time period.
Is there any bargain around?
The question now arises whether or not the crash in the prices of social media stocks has caused some bargains to resurface. We shall check current valuations of a few chosen social media stocks, such as LinkedIn, Zynga, Groupon, Facebook and Yelp (YELP).
A few words on the companies above:
- Groupon: I believe that its business model is obsolete and also highly sensitive to economic times. When times are not so great for shopping, Groupon will be the first item that consumers drop off their list. In addition, The company was involved in an accounting scandal on April. To me, an accounting scandal is a deal-breaker. I will never recommend this company, regardless of how low its share price may be.
- LinkedIn: To me, this company is an enigma, much like Amazon (AMZN) but much less established than Amazon. Both companies trade at insane multiples, yet both are given strong feedback from the market in anticipation for continued future growth to support share price. This is a classic growth stock, not a value bargain.
- Yelp: This company operates in a business segment where barriers to entry are slim to nonexistent. Not only that, but even after its share price was pretty much halved, it still trades at extremely high multiples for a company that is not able to show a positive net income line. Whatever happens, paying more than 8 times book value for any company is downright silly.
- Zynga and Facebook: I have put both companies together because the success of one depends so much on the other. Of the two, I would choose Zynga for the following reasons:
- It has finally become truly cheap. At a Price/Book value of less than 1, and a modest Price/Sales, Zynga is trading on the cheap.
- The gaming industry is growing at an extremely fast pace. Zynga is likely to get many future users hooked to its games. This will provide the company with a constant stream of income, whether or not social media flourishes.
Buy shares of ZNGA for no more than $2.8. I recommend not to chase the price higher but wait patiently and buy on pullbacks.