The invention of new information technology has caused creative destruction in mass media and marketing. As a consequence the marketing tools businesses use to acquire and engage customers are changing dramatically. This trend will continue as new mediums displace old ones and new entrants shake up established marketing veterans. This chaotic environment is good for entrepreneurs and scalable startups, but bad for large incumbent market leaders.
Investors who are interested in speculative bets could find companies that offer attractive marketing services while trading at reasonable market capitalizations.
From Traditional Media to Web 2.0
There have been multiple revolutions in media and advertising in the past twenty years. Notably, the ascendancy of the internet has proven to be a challenge to television, radio, and print newspapers. The consequences of this widespread challenge to traditional media are still being felt. For example, analysts estimate that advertising revenue for The New York Times (NYT) dropped 10.8% in the third quarter of 2012 year-over-year. Television is in the same boat as streaming services like Netflix (NFLX) and YouTube now compete with broadcast and cable for viewers.
Firms which were once the winners of prior market shifts are targets for disruptive innovation. AOL (AOL) was a web portal and content provider which dominated how people accessed the internet. Its dominance was usurped by directories like Yahoo (YHOO). Later search overwhelmed these directories led by Google (GOOG).
The story does not end at Google. No media company is safe from disruptive changes. In The next wave of digital growth is here Todd Harrison wrote that web portal usage is down 24% while social media or "web 2.0" has grown 52%. These changes demonstrate how the economy of the net is fundamentally changing. New developments in the "hypernet" threaten to undercut web search. In the third quarter of 2012 Google saw search revenue deceleration at the hands of Facebook (FB) in the social media space and searches using Apple's (AAPL) mobile devices.
These changes in media consumption are creating opportunities for direct marketing and word-of-mouth, too. Groupon (GRPN) has combined the concepts of email lists and mailer-distributed coupons. Mobivity (MFON) offers a marketing tool to engage a firm's customer base through text messages. Mobivity is interesting because it is a way for businesses to monetize mobile device use.
Yelp (YELP) is analogous in that it created a web-based version of word-of-mouth peer reviews. Each of these services has the potential to dramatically increase a business's sales.
Apparently new media forms also allow consumers to reset their existing attitudes about old marketing strategies. For example, consider the acceptance of Groupon. People hate junk mail and they hate email spam yet somehow the combination of both is beloved in Groupon. Society's reaction to these companies is inconsistent, and this inconsistency allows for marketing companies to redeploy and reinvent older strategies outside of old prejudices.
Opportunity in Technological Turmoil
Stock investors should pay attention to how much they are paying for a stock, regardless of how often pundits say that growth will justify any price. Unfortunately, valuation metrics are often useless when evaluation burgeoning tech companies. Though earnings multiples are desirable, many of these firms run losses as they ramp up, and so price-to-earnings ratios are less useful. Price-to-book ratios should not be used to compare tech firms because internal research and development is not capitalized, which may understate the value of firm assets.
For technology stocks the price-to-sales ratio is paramount since it allows some form of comparison between companies which might have off-balance sheet assets or are currently running losses. Gross margins are also useful since they allow investors since they give a rough view of whether the firm's sales cover direct expenses.
Consider the following data regarding technology stocks that impact media consumption:
Market Cap ($ Millions)
Of these firms, Groupon and Mobivity are trading at the most attractive revenue multiples. They also boast attractive gross margins while trading at low market capitalizations. Mobivity is somewhat extreme in this respect since its tiny market capitalization goes hand in hand with illiquidity of a stock that is traded over-the-counter. Yelp is also a small firm, but it trades at the highest price-to-sales ratio on this list.
Investors should shy away from companies with large capitalizations that trade at high price multiples. Facebook is a prime example of this: its high price-to-earnings and price-to-sales ratios are hard to justify since it is already a huge, established stock. Small caps, micro caps, and nano caps are more likely to see their operations increase multi-fold and they have yet to exhaust demand in the market for their equity. This concept is hardly new: investors should avoid large cap stocks which trade at high multiples based on the value effect and on the market size effect. These phenomena have historically favored stocks that trade at lower multiples and stocks that trade at lower market capitalizations.
Apple is a safer growth investment that trades at reasonable price multiples when compared to Google and Facebook.
Groupon and Mobivity are interesting speculative bets in a dynamic industry. Investors who are looking for a safer way to play changing media consumption should consider Apple. Its mobile devices are the platform upon which more and more media is consumed.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.