Before the pine beetle was discovered, some loggers cut down a tree to find beautiful, unique-looking wood with an interesting blue hue. This rare discovery generated wild interest; it was something people had not seen before. The hype grew, people thought they'd found treasure, and sculpture from this wood sold for thousands of dollars. Before time, however, they discovered their assets were rather worthless, as the pine beetle started to sweep across western North America. The altered pinewood soon became all too familiar as the work of an insect creating an epidemic in the forestry industry.
When hype is generated about things we do not fully understand, it's human nature to believe it could be valuable. Some people have found clever ways to exploit this tendency to further benefit themselves. Indeed, early traders would often trade useless shiny objects to the natives for valuable furs; Mark Cuban sold the now extinct Broadcast.com into a $5.7 billion acquisition; and Sean Paul became a famous singer through songs that are essentially gibberish. So our advice would be: beware of hype.
Difference between internet and technology stocks
I caution investors to understand the difference between a technology stock and an Internet stock. Please do not compare LinkedIn (LNKD) with Microsoft (NASDAQ:MSFT), or Groupon (NASDAQ:GRPN) with Apple (NASDAQ:AAPL). The biggest mistake an investor can make is judging an Internet stock and forgiving it for losing money in its early years. "Don't worry about Groupon's losing $0.39 per share, they're still working on their new …" Can't quite fill in that blank with an Internet company, can you? If you want a complete explanation of why Groupon shares will plummet, consult my previous article.
I believe LinkedIn is a fantastic service. I recommend all people sign up for this website, based on it's ability to utilize the importance of social networking, while making sure it allows people to display their professional profile. As long as people are not comfortable with their bosses, coworkers, and interviewers seeing how drunk they got last weekend, this service will always be a great compliment to Facebook. That said, we should ask ourselves: "Where does the value lie with this company?".
Overinflated LNKD valuation: Based on its previous earnings per share of $0.07, LinkedIn was trading at a P/E of 1,046. Let's stop here, and let that resonate for a bit. LinkedIn's market cap is over $7 billion. Once again, I'll let that settle in.
Recently, LinkedIn released its Q4 results and showed revenues are up 105% compared with the same quarter last year. That is a great accomplishment for any company, and the management should be proud of such a successful quarter. Its year-end EPS is now $0.11, up 0.04. That is again truly impressive, and a great achievement.
Subsequently, LNKD is up almost 9% and will presumably continue to rise in the coming days based on this news, corroborated by the anticipation of Facebook's IPO. All I can caution you again is: beware of the hype. The company needs to see its EPS grow exponentially to justify its price of $83.15. I cannot see this social networking site start making huge amounts of money without compromising what made it successful in the first place.
Beware of the hype creators: Unfortunately, most investors look towards the giants for advice. They should also understand though, the ulterior motives of advice when pertaining to the investment world. When Bank of America (NYSE:BAC), JPMorgan Chase & Co. (NYSE:JPM) and Morgan Stanley (NYSE:MS) say anything about LinkedIn, ask yourself: "Are they impacted at all by their position as the company's top underwriters?".
Fire LinkedIn from your portfolio: The sun will one day set on the shares of LinkedIn. It's a great company, providing a valuable service. However, its true valuation will never come close to what the market has it priced at today. It's only a matter of time before this is exposed. Furthermore, as soon as LinkedIn starts to manipulate its service in order to generate value for shareholders, the door will open for competition. The competition will start locally, like with all of these Internet companies. If this competition provides better service, it will grow. Just ask Myspace how they feel about Facebook (NASDAQ:FB).
If you only take away one suggestion from this article, I hope it's my sincere recommendation that you should avoid the Facebook IPO at all costs.
Many people I've talked to are looking to ride the initial wave upwards and get in on the hype. Others are looking to short, when they believe the company has hit its peak after a week or two. To all these people, I wish you good luck and I will live vicariously through you as it pertains to this investment. I will short Facebook one day. You can count on that. But this IPO is not for the little people. Let the big boys make a mess of it and see where things are once the dust settles.
Facebook valuation: I love Facebook. I go to Facebook everyday to keep up to date on my social network, post on my friends' walls, and creep on people I haven't talked to in a long time (bad habit, weird habit).
Based on the private market, Facebook is valued to be worth over $100 billion. Write that down. Facebook is worth $100 billion. Doesn't that just feel wrong? It should. This would value the online social networking company higher than PepsiCo Inc (NYSE:PEP). At $100 billion, it will be valued at 26.9 times trailing 12-month sales. The expected IPO is going to put Facebook on the high side of the $75 billion-$100 billion valuation. I will concede that its revenues of $2 billion are very impressive, but ask yourself, is there really that much more room for growth with Facebook? How many people do you know who do not use Facebook and will start in the next couple years?
Future direction: Facebook didn't decide on a whim to go public a few weeks ago, this has been in the works for a long time. Facebook has never been as hyped as it currently is. Its CEO has been Time magazine's Person of the Year, it had an extremely popular movie focused on its creation, and its fully submersed into everyday North American culture (please "like" this article). This company shows all the signs of my high school experience; it's reached the peak of its popularity.
I was messaging my friend on MSN Messenger earlier about how ridiculous their favorite music is on Myspace. Oh wait, that was 10 years ago.
Effect of 1,000 new experts: Once Facebook goes public, it will have every shareholder looking for the promised growth that justifies its outrageous P/E. As the company tries to gain value through its service, one can expect the user's experience will be negatively impacted. This will open the door to all the other social networking sites on the planet. If you don't think that will be an issue, go traveling. There are successful social networking sites all over the world, which are more popular in their home countries than Facebook. It would not take long for these websites to hop across borders, just as Facebook did, if its service is diminished due to advertisements or any other value creating actions.
Finally, Mark Zuckerberg makes me feel uneasy as someone I'd be investing in. I'm not basing this on anything other than gut feeling. I don't want that man using my money.
We are going through a period of extreme hype behind stocks where nobody understands all degrees of their business model. One day we will look back at the IPOs of LinkedIn, Groupon, and Facebook and truly see the madness that currently resides within the investment world.
Disclosure: I am long MSFT.