When investing in hot social media stocks, it helps to ignore the hype and just look at the numbers. After all, numbers don't lie. This article is just that. Numbers for Twitter (NYSE:TWTR), LinkedIn (LNKD) and Facebook (NASDAQ:FB), compared to Google (NASDAQ:GOOG) for the last four years. I use Google as a benchmark because it is a well-established but still growing online services company competing for online ad dollars with all these newer entrants.
How fast are they growing?
All three - Twitter, LinkedIn and Facebook are growing fast. Very fast. A lot faster than Google. In percentage terms, this is what their growth looks like:
The 2013 Estimates are based on 4/3*first three quarters of the year.
We can see that while Google about doubled its revenues in 4 years, Facebook more than tripled them and LinkedIn revenues for 2013 are projected to be nearly 6 times those of 2010. Twitter, the fastest revenue grower stands at nearly 20 times those of 2010.
What about profits?
Profit growth on the other hand paints this completely different picture:
While Google showed consistent profit growth, the profit growth has not kept up with revenue growth. Profit grew only half as fast as revenue. Facebook's profit for 2013 from this graph is the only one to grow as fast as revenues. But Facebook did have a comparatively dismal 2012. LinkedIn is next for consistency, with profits doubling, but still not keeping up with revenue growth. Twitter is the worst of the lot and the only loss maker in the group. It seems to be trending towards even more losses.
I will look at valuation in several ways. For the purpose of this article, I will assume that Google is fairly valued and attempt to arrive at a valuation for the other companies based on their growth compared to that of Google.
First, I'll attempt to value Facebook and LinkedIn based on their earnings growth compared to Google. I will assume that they will continue to grow at their average earnings growth rates for the last three years, with the average arrived using: (earnings in 2013 - earnings in 2010) divided by 3. I used this method because Facebook's 2012 was throwing averages off enough to make the real average pretty much useless. For LinkedIn, this number was the same as the average growth number anyway.
Using this growth rate, I calculate a "deserved P/E" assuming a high growth rate implies a proportionally higher P/E. So double the growth rate implies double the P/E.
|Earnings Growth Rate (Average)||P/E||Deserved P/E||Deserved Stock Price|
This makes LinkedIn look seriously overvalued, at least based on earnings.
Next, I'll look at the companies differently, based on revenues and the P/S ratio as opposed to the P/E ratio. With this method, we can also add Twitter into the mix. I use the same logic as the P/E above to calculate "deserved P/S".
|Revenue Growth Rate (Average)||P/S||Deserved P/S||Deserved Share Price|
However, the above calculations assume that the companies can continue growing revenues at the average rates that they have been growing for the last three years. That is extremely unlikely.
It is more realistic to assume that the revenue growth rates follow a trend and will stabilize as shown below.
In this case, the updated table would look like this:
|Revenue Growth Rate (trend)||Deserved P/S||Deserved Share Price|
In conclusion, stay away from the hype. All the social media stocks are overvalued and if I were to pick one, it would be Facebook because earnings are after all more important than revenues. For LinkedIn or Twitter, I would wait for a serious correction before even thinking about them.
Disclosure: I am long GOOG, FB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.