On November 27th, 2012, I recommended to buy shares of Zynga (NASDAQ:ZNGA), the gaming company of the new social media era. When I initially recommended it, shares were trading for $2.25, after taking a long hard dive from the ~$15 level. Take a look at the graph below.
Shares quickly rebounded to the $3.7, a jump of 70%, only to retreat back to $3.2.
The investing rationale
We always like to look in the bargain bin for potential, deserted value gems. The previous year was extremely tough for the social media industry and it led various companies to the brink of bankruptcy. Specifically, since February 2012, the share price of Facebook (NASDAQ:FB) was cut by 40% while shares of Zynga and Groupon (NASDAQ:GRPN) simply evaporated 75% of investor's capital. Only naturally, such an intensive crash in the prices of social media stocks has caused some bargains to resurface. This was our cue to enter into a position.
On valuation and momentum
You need both valuation and momentum on your side before you enter a position. Back in November, Zynga was trading at a Price/Book value of less than 1, and a very modest Price/Sales. Zynga was trading on the cheap. In addition, the company was extremely hated by the market partly because it caused some devastating losses to early shareholders. The Put/Call option ratio reached an extreme level, indicating extreme pessimism towards the future prospects of Zynga.
But now, after a quick 70% run, shares are no longer cheap enough for us. On the technical front, shares hit a road block at the $3.5 and retreated to $3.2. In addition, investors and analysts alike are now suddenly excited about the prospects of Zynga. You can suddenly find more and more 'Buy' recommendations for the stock on SA, like here and here. When too many analysts are screaming "buy", it is always a good idea to fold your cards and head for the exit.
Sell to close our long position in Zynga. Let's bank profits of 40% in just under 3 months.