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Two major events in May continue to dominate the direction of technology stocks in a negative way. The 20% drop in Facebook (NASDAQ:FB) shares after its IPO is leading the decline on the Nasdaq. Worry in the eurozone is also highlighted, with higher bond yields in Spain and a rising likelihood that Greece will need to leave the eurozone.

On the Nasdaq exchange, "The Facebook Effect" is proving to be widespread. Facebook's poor share performance is hurting social networking stocks including Yelp (NYSE:YELP), Groupon (NASDAQ:GRPN), and Zynga (NASDAQ:ZNGA). Only LinkedIn (NYSE:LNKD) has been up in the last five days:

Chart Source: Yahoo Finance

With the volatility index at levels not seen since March, investors should be not holding any pure-play social networking companies. Companies that benefit indirectly from the growth in social networking are the exception: they are companies to accumulate.

First off, Facebook, whose shares closed recently at $28.19 and are down 26.26%, is a company to avoid. Underwriters revised forecast in the earnings power for Facebook, but did not disclose the revisions to all investors. The 2013 full-year estimates were revised as follows:

  • Morgan Stanley (NYSE:MS), from $0.88 to $0.83
  • Bank of America (NYSE:BAC), from $0.66 to $0.66
  • JPMorgan (NYSE:JPM), from $0.70 to $0.66
  • Goldman Sachs (NYSE:GS), from $0.68 to $0.63

Although Facebook does not trade on fundamentals, the following chart below illustrates the corresponding P/E for each share price level. The figures are forecasts from Morgan Stanley:

2012E

2013E

Share Price ($)

$0.48

$0.83

9

18.8

10.8

11

22.9

13.3

13

27.1

15.7

15

31.3

18.1

17

35.4

20.5

19

39.6

22.9

21

43.8

25.3

23

47.9

27.7

25

52.1

30.1

27

56.3

32.5

29

60.4

34.9

31

64.6

37.3

33

68.8

39.8

A combination of lower global advertising spend and a lack of a proven mobile advertising strategy suggests Facebook will continue to trade lower.

Zynga shares fared the worst after Facebook began trading. Shares closed at $5.87 and now have a market capitalization of $4.32 billion. The drop is expected: prior to the Facebook IPO, Zynga had a market capitalization greater than that of Electronic Arts (NASDAQ:EA) at $4.69 billion and Take-Two Interactive (NASDAQ:TTWO) at $1.05 billion. Draw Something, an app developed by OMGPOP, once attracted 9.1 million monthly active users on Facebook in March 2012. After debuting with 36 million downloaded, activity dropped nearly 30% between April and May:

Chart Source: AppData.com

Server problems might be part of the reason explaining the drop in activity. Zynga is shifting traffic to "Z-cloud," but server issues are resulting in dropped users or player moves. If the popularity of Draw Something continues to drop, the reputation of Zynga's management will be called into question.

Now that speculators are withdrawing support for Facebook and Zynga shares, they are stating that hyperactive user-growth does not necessarily translate to earnings. That is why Shutterfly (NASDAQ:SFLY) is a compelling offshoot to social networking stocks. The company has a proven history for making acquisitions that fit the business and make financial sense. Shutterfly recently acquired Kodak's Gallery for just $23.8 million. The Kodak business has 75 million users, and it also has an app that connects to Facebook, along with traditional email and text. Kodak's online photos are scheduled to move to Shutterfly in July.

Source: Avoid The Social Media Burst, Buy Shutterfly Instead