Why I'm Avoiding Social Media IPOs Until The Dust Settles

by: Kevin Quon

The recent frenzy behind the social media IPO spree that saw the launches of well-known Internet giants like Pandora (NYSE:P), LinkedIn (LNKD), Groupon (NASDAQ:GRPN), Angie’s List (NASDAQ:ANGI), Zynga (NASDAQ:ZNGA), and Zillow (NASDAQ:Z), have left one clearly defined message: The market has no idea how to value these Internet-based companies, and investors undoubtedly want to be a part of it.

LinkedIn (LNKD) made this boggling process of assessing valuation abundantly clear back in May 2011. Despite an IPO at $45/share, closed private transactions had priced the company at just $14.5/share just one year prior in April 2010. By the end of the first day of trading, LNKD had doubled its supposed valuation as it closed at $94.25/sh having even reached intraday highs of $122.7/sh.

Such price fluctuations were not reserved for LinkedIn alone. Groupon dropped 40% from $25/sh to $16/share before settling around its current value of $23.05/sh. Pandora rose to $20/sh before falling back down to its current price of $10. And Zillow has seemingly yet to find a fair value as it continues to jump around in between a range between $40 and $20.

Anxious investors wanting to not miss the hype of these companies might do well to relax and consider the valuations being placed onto a few of these companies in light of their forward P/E ratio’s:

Company Market Cap. 1-Year Earn. Est. Fwd P/E
Pandora (P) $1.60 B $ (0.01) ??
LinkedIn (LNKD) $6.13 B $ 0.51 123.27
Groupon (GRPN) $14.70 B $ 0.27 85.37
Angies List (ANGI) $0.82 B ? ?
Zynga (ZNGA) $6.82 B $ 0.20 48.75
Zillow (Z) $0.65 B $ 0.31 75.61

Investors pay for growth, but until that growth is realized it’s only speculation. Perhaps the following two companies can serve as a reminder for what happens when Internet realities can begin to settle in:

Company Market Cap. 1-Year Earn. Est. Fwd P/E
Open Table (NASDAQ:OPEN) $0.97 B $1.48 27.5
Travel Zoo (NASDAQ:TZOO) $0.41 B $1.69 15.17

The stock market may definitely seem chaotic at times, and new highs or new lows may frustratingly be thought of as a new normal even when they still remain undefined at best. But prudent investors might do well to remember that eventually all stock prices become rational reflections of a company’s ability to return value to the shareholders. It may take years. But that’s just how the free-market economy works.

Some of the aforementioned stocks may be cheap depending on their growth rates and the sustainability of those growth rates in the long term. But there's several years down the road for the earnings to catch up with the current expectations. All the while, there is the risk that growth may be stifled by some unknown factor yet to be revealed or by the plateau of the company's full potential. For myself at least, I believe that's just an abundance of unnecessary risk to be taking during a time of economic uncertainty.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.