Social Media Stocks: The 3 Questions That Matter

| About: Global X (SOCL)

We have seen it before, Railroads, Radio, Airplane, Television, Computers and Internet Equities.

The current trend; Social Media Stocks.

There are enough articles out there which concentrate on valuing each social security, be it Facebook (NASDAQ:FB), Zynga (NASDAQ:ZNGA), LinkedIn (NYSE:LNKD), Pandora (NYSE:P), or Groupon (NASDAQ:GRPN). This article intends to look forward by using what we know in the past, and apply certain factors which exist in the "Social Stocks".

Every 10 years or so it seems, the world never fails to introduce a group of companies that link towards a brand new industry. Initial Public Offerings are always hot on the headlines, with publishers and investment bankers pushing the public onto the new "hot" security. Retail investors get sucked in, believing in the never ending high expectation and projections of triple digit increasing revenues quarter-by-quarter. Less the retail investors forget, the less marketed stocks of the past, Computers, Radio, Television, Railroads lay forgotten.

While Social Stocks do comprise of a new category of equities, they possess interesting characteristics of changing the playing field in many ways. Unlike their predecessors, the unique attributes below showcases potential and limitations in top and bottom lines. There are certain unwritten qualitative rules in which Social Stocks operate better through observation.

1. What is the key in determining the value?

In the world of Social Media business, like financial stocks, bigger is better. The word "bigger" refers to the number of engaged users for that particular platform. It is extremely difficult for new entrants of products to overtake a leading provider when the leader is actively managing engagement of their users. Examples can be seen with the messaging platform Whatsapp and BlackBerry Messenger. The case of Whatsapp success lies heavily on the fact that BlackBerry failed to provide a cross-platform delivery system before the need was prevalent. While BlackBerry's Messenger was the most widely received concept of free messaging before Whatsapp, they lost footing in being the first-mover of grabbing market share. In order for consumers and businesses to retain their competitive advantage, Social Stocks needs to have a high number of engaged user base.

Majority of existing articles focuses on trying to generate revenue per user, while that is important, more importance should be placed on the "loyalty" per consumer.

To value such a metric on user base, a better question would be, "What are the chances that the current user will willingly switch providers?"

We look at the second factor to answer this question.

2. Hardware trends is a huge factor in determining value

The flexibility of social service providers is extremely important in maintaining engaged consumers. The way consumers use technology has a very big impact on winning votes for the best "application".

Facebook faced such a challenge when they designed their platform for the laptop/personal computer. By doing so, they allowed Instagram to capture a rapidly growing market trend when the world started to shift towards a "mobile" application platform. While Facebook was good at delivering social content to users, the first factor, a loyal group base of users; Instagram delivered the SAME service to a different setting, thus capturing the market before Facebook. While Facebook managed to create a similar application, the damage done by Instagram was too great that it resulted in a buyout.

Blackberry's Messenger platform, ICQ, MSN Messenger; all faced equally changing consumer tastes and failed to migrate before their users react. The flocking towards Whatsapp when the need was identified created strong momentum for Whatsapp to maintain their current user base. While Facebook tried to create similar changes in their messaging application, the momentum was too great and they purchased Whatsapp of recent.

In answering the question, "What are the chances that the user will willingly switch providers?"

Generally the security in which investors choose should be flexible and dead first in switching platforms BEFORE they have been identified by the consumers. Usually when the consumers discover the needs before the Social Stocks, it is too late.

That brings in our next question on determining value of Social Stocks,

"What are the tell-tale signs that the consumers are moving platforms?"

3. Respect the teenager

Teenagers are probably the most sort-after people in identifying trends. Teenagers usually are the first to adapt to whatever is moved by the marketed media. In contrast, getting working adults to switch trends/platforms is often liken to getting taxes filed months in advance.

In the Social Media World, there are a few factors in which make it preferable for Teenagers to identify platform/trend changing; The observation of teenagers are commonly;

  1. Strapped for Cash
  2. High "face-value" for money
  3. Most cost effective way to boost expenditure

Generally with the above attributes, we can identify the 3 factors which lead to platform/trend changing;

  1. People change when the entry-cost is low/no-difference
  2. The return on change is a boost on first-impression
  3. The overall value received far exceeds predecessors

Comparing to why screen-only phones replaced the old keyboards;

  1. The entry-cost is low/no-difference
  2. There is a wow factor
  3. The value received far exceeds predecessors

In answering the question, "What are the tell-tale signs that the consumers are moving platforms?" the above 3 factors need to be taken into consideration. While people are resistant to change, they do eventually change when the cost is low and the value is high.

In retrospect, Social Media Businesses need to create new markets to grow. As the growth of user base and adoption of technology is often face paced, to sustain such growth is to either buy over entire engaged userbases or create new platforms that have rapid growth.

4. All being said and done, "How do I value Social Stocks?"

The crux of the article paves way into valuing the new era of stocks. The factors above has proved that it is very tricky to value growth potential. One of the key differences that social media companies are able to expand their reach of consumers is due to the freedom of the internet. Unlike previous growth industries like airlines, television and automobiles, even the hardware computers, they are very often limited to certain laws to expand their trade as fast as social media stocks. Import/Export tariffs, manufacturing and supplier constraints limit their growth speed. In contrast, one application like Whatsapp can be created, distributed and marketed in a few years and be sold for 19 billion.

In a corporate view, one of the only ways in which investors can hope of making sizable low-risk high return capital gains in the short term horizon is to identify markets that have huge upswing potential that leads to a complete buyout. Often, initial public offerings are at a stage in which most retail investors have arrived into the party extremely late.

While social media stocks have faster growth curves as compared to traditional growth hardware industries, the fallacy of human emotions pave way for business failures. The Blackberry may be a star in the past but may be a dying star in the future. Likewise, whatever is hot today may be dead in the next cycle.

By looking at the past of how other sectors react towards growth markets, it is often the assistance companies which performs the best. During the aviation boom, the business which distributed the engines of aircraft, Boeing, thrived while the buyers faced rapid changes. During the boom of smartphones, Corning Glass prospered due to their Gorilla Glass Technology despite heavy competition across brands. Likewise, while social media stocks are trending, the industries that thrive may include those that are the supporters rather than the face of the trend.

There are over 1,000,000 applications in the Apple Store. Choosing a potential winner is challenging to an average retail investor. However in summarizing our above factors, the investor can narrow his choice to the questions;

Putting it in practice;

  1. Is the number of engaged users big?
  2. Is there any chance that the users will leave for something else?
  3. Are there tell-tale signs that the consumers are currently moving platforms?"

Basically, the business is dead when users leave. The only thing that social media companies need to focus on before revenue per user, is to engage, retain, attract and grow the number of users. Any social media business that passes this key metric, will do well in this new era. In contrast, they will be crushed if they don't.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.