There's a scam working in social networking, and you're the intended victim.
Everyone knows that companies like Facebook and Groupon (NASDAQ:GRPN) are not worth the valuations private capital placed on them earlier this year. So how do you find a greater fool?
You do what LinkedIn (NYSE:LNKD) did. You go public, but don't put out enough shares to soak up demand. This yields an extremely high price, which is then held to insiders' shares.
Take a look at LinkedIn's IPO document and pay special attention to the section on principal and selling shareholders. Note that barely 20% of the directors' and major investors' shares were being sold.
Trefis noted that employees were still having to hold their stock private, by contract, in July. They warned of significant dilution and had a price target of $30 on the stock. Its price at that time was $107; it's currently at $94.
At $94/share LinkedIn is priced at a multiple of nearly 30 times its estimated 2011 revenue. Not earnings, revenue. It's the greater fool theory, and you, the public investor, are the fool.
In this case it's even worse than with LinkedIn. Groupon is losing money, hand-over-fist. Try $2.66 per common share last year, and on course to lose almost $4/share this year. Revenue is great, $700 million last year and almost $645 million in the first three months of 2011, But it's more than made up in expenses – selling, general and administrative expenses last year were nearly one-third of the revenue.
This is the kind of manipulation you have to watch for when evaluating new companies. How many of the shares are being held back? When can they be sold? How much of the company is the public really buying?
This is not the 1990s. For one thing, social media represents a much smaller part of the market than Internet stocks did in the last century. For another, most are going public with balance sheets which appear to show sales, and sometimes even profits.
But you're not being told the whole story. What you're buying is speculation and momentum, not a real company. When shares fall in value, there is no floor under them. Buyer beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.