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We are living in an era of social media which completely changed our means of communicating with one another.

It was only a matter of time before these companies began communicating with the stock market via IPOs and share issuance.

Back in February, I wrote an article advising investors to steer clear of social media stocks. Investors who took the time to listen saved their trading accounts from blowing up.

What happened to social media stocks since their IPOs?

P/EIPO priceCurrent Price% Change$10,000 turned into...
Facebook (NASDAQ:FB)70$38$27-29%$7,100
Groupon (NASDAQ:GRPN)

N/A

$28$9.95-64%$4,600
Zynga (NASDAQ:ZNGA)N/A$11$4.98-54%$5,600
LinkedIn (NYSE:LNKD)647$83$94.4614%$11,400
Yelp (NYSE:YELP)N/A$22$19.65-10%$9,000

It is often extremely difficult to put a price tag on 'hype' or exciting stocks. But I believe the table above gives you a decent idea of what the cost of excitement in the markets really is.

By taking a quick look at the list above, you must realize that many investors and traders alike lost a whole lot of money on these stocks. These types of losses are in fact very hard to recoup due to their size.

But the writing was on the wall. Practically all of the stocks were issued at a time of a general hype surrounding this sector. I personally heard of cases when mothers rushed to cash their children's savings in order to buy Facebook shares. As a result of this hype, the valuation multiples of these stocks were sky high. Since everything eventually regresses to the mean, it was only a matter of time before a strong correction takes place. It is now happening.

That is not to say we did not take any part in this fiasco. On April 3rd, we decided to short GRPN after we had an additional catalyst to do so (the company was forced to revise its 2011 Q4 report as a result of underestimating its customers' refund rate) other than plain valuation. Only a month later, we took our 30% profits off the table to protect our gains.

As you may recall, our rule is to never short a stock based on valuation alone. We must wait for two signals: one is an overextended valuation and the other is a catalyst. The catalyst can be a financial scandal, a management fiasco or any other event with a robust negative effect on the company.

What's on our short list right now?

LNKD is currently on our short radar, for the following reasons:

  1. It has no "economic moat" of any kind. In fact, it is technically inferior to search engines that have much more sophisticated algorithms at work.
  2. It is currently trading at obscenely expensive valuations: PE of 650, Price/Book of 15 and Price/Sales of 16. These valuations are unsustainable.
  3. It is a very exciting issue, too exciting. In my experience, when these internet issues fall, they fall hard and fast.

What we do NOT yet have in LNKD is the type of catalyst I mentioned above. We are also waiting for the stock price to violate the $88 downwards.

What's an investor to do?

For now, simply sit tight and enjoy the ride. Not trading is, in fact, a trading decision and you must fully recognize that. I do not think it is a good idea to short any of these stocks right now. There is a great amount of risk in M&A activity in this segment.

What we will do is wait for some catalyst on LNKD other than its ridiculous valuation, before we short it. Once we decide to short the stock, it will be a sweet ride down the slope.

Source: Where Are These Social Media Stocks Heading?