Cocktail Party Stocks: Investors Are Better Off Elsewhere

by: NakedValue

Facebook and Pandora Media (NYSE:P) are two of the hottest companies in the finance world. The stock market could be valuing Facebook at more than $140 billion valuing Facebook at more than $220 billion based on the spike in GSV Capital Corp (NASDAQ:GSVC)'s stock price following their investment in Facebook. Pandora's recent IPO was in such high demand that underwriters had to increase the pricing twice before finally settling on the final IPO price.

As such, maybe it should not have surprised me to hear people talk incessantly about these two stocks at a cocktail party that I recently attended. But the most popular stocks at cocktail parties are rarely the best investments. Why? Because when everyone is talking about the stock, there is probably so much eagerness to purchase the stock that it pushes the stock price to undesirable valuations.

Pandora Media, with a market capitalization of around $2.6 billion, trades at a price/sales of 15.5. Sure, this is a fast growing opportunity, but they make little money, have largely unproven pricing power and limited economies of scale.

LinkedIn Corp (NYSE:LNKD) is similarly interesting. The company has developed a strong brand -- the essential professional network. From 2009 to 2010, revenues more than doubled. But at a price/sales of 22.61, investors should be skeptical of the stock. is the current white whale in the technology world. The new internet bubble is well under way. As technology investment bankers and venture capitalists party like it is 1999, like any important guest, is fashionably late to the IPO party. Still, they have continued to aggressively raise capital at ever increasing valuations. Their stock placement deal with Goldman Sachs in January 2011 valued the social media giant at $50 billion. More recently, their deal with GSV Capital values Facebook at $70 billion. But as we have indicated, the stock market could be valuing Facebook at more than $220 billion. This would put the company at the same market size as Google, Inc (NASDAQ:GOOG), a company with a much better established advertising business.

We don't disagree that Facebook is a great company with a strong brand and a "sticky" product, but valuations are likely outpacing growth in the company's potential. According to the Wall Street Journal, Facebook had revenues of $777 million in 2009 and analysts estimate that they may have earned $2 billion in sales during 2010. This is great revenue growth, but to justify a $50 billion, $70 billion, or $220 billion valuation, revenues will have to grow at a much greater rate. This could be problematic in light of the fact that users are declining in Facebook's more established markets.

I understand most of the bull thesis about stocks like Pandora, Facebook, LinkedIn and Groupon etc. For the most part, I am also very bullish of the companies, and excited about the changing industry landscape. However, the stocks are not exciting at these valuations-- especially when high profile, profitable, growing technology companies can be purchased for much better valuations.

Microsoft Inc (NASDAQ:MSFT) was everyone's favorite tech stock bad guy during the last technology bubble. They were disdained for their image of anti-competitiveness and maybe worse than that, Microsoft was so ubiquitous that they were considered, gasp...uncool. In the last decade or so, not too much has changed at Microsoft. While they have developed a successful gaming platform and a competitive internet business, the company's still dominated by their computer operating system segment and computer business software segment.

What has changed is the valuation. The company is making record earnings but because of a paltry price/earnings valuation and management's decision to return capital to shareholders through share buybacks and cash dividends, the company is no longer the biggest technology stock in the world. But ultimately, those sorts of bragging rights are reserved for billionaires. Common investors should focus on per share valuation and when they do, they will realize that Microsoft Corp is a wonderful investment opportunity.

MSFT trades at a trailing P/E of 9.62, a forward P/E of 8.74 and a PEG ratio of 0.90 despite generating 31.7% profit margins. Perhaps the most amazing thing about this stock's valuation is that it also ignores upside potential from adoption of Windows based operating platforms for mobile devices. At this point, Nokia Corp (NYSE:NOK)'s partnership with MSFT is still in development, but the landscape is ready for a major mainstream competitor to Apple and Google. As such, this upside opportunity is Microsoft's to squander.

Apple Inc (NASDAQ:AAPL) - No longer the technology world's brooding outsider, Apple is the king of the technology world. They are one of the few consumer electronics companies with pricing power, they may revolutionize the PC market with their iPad and they will likely finally push consumers to finally embrace cloud computing on a wholesale basis with iCloud. Anyone should agree that this company is every bit as compelling as the Facebook, Pandora and LinkedIn's of the stock market, but Apple's stock also offers great value.

Apple trades at a trailing P/E of 15.89, a forward P/E of 11.61, a PEG ratio of 0.61 and generates profit margins of 22%. In addition, sales grew 52% from 2009 to 2010.

Google Inc (GOOG) - Not long ago, Google was the most popular stock on the cocktail party circuit. Since then, the company has lived up to much of the hype and continued to innovate and build out its advertising operation. What's the company's reward for fulfilling its promise? Valuation multiple compression. The search giant now trades at a trailing P/E of 18.89, a forward P/E of 12.32 and a PEG ratio of 0.82. This is despite growing revenues 23.9% from 2009 to 2010. They currently trade at 4.9x trailing twelve month sales.

For all of the stock market's bullishness over Facebook, it may be easy to forget that Google already has a dominant and growing online advertising business. At these valuations, investors may be better off investing in Google, Inc. than hoping that Facebook one day achieves that same success.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL, MSFT, GOOG over the next 72 hours.