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Are Social Networking Stocks Overvalued?

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Are Social Networking Stocks Overvalued?  How To Answer The Question

Twitter Stock ValueWith Twitter (NYSE:  TWTR) joining the list of publicly traded social networking stocks, and many of the stocks making monster runs higher during the later part of 2013,  traders and investors are wondering:  are social networking stocks overvalued?  That is a fair question given the lofty valuation that the major social networking stocks trade at.  By just about any valuation metric, the major social networking stocks are at incredibly high valuation levels.  The question that needs to be answered is:  based on projected forward revenue and earnings growth are these stocks overvalued, fairly-valued, or even undervalued?


Current Valuations and Future Prospects of the Major Social Networking Stocks

Facebook Valuation
While there are numerous publicly traded social networking stocks, there are in actuality only three major ones, including:  Facebook (NASDAQ:  FB), Twitter (NYSE:  TWTR) and LinkedIn (NASDAQ:  LNKD).  The three major stocks performed differently after their Initial Public Offerings (IPOs) for various reasons; however, they all rallied hard towards the end of 2013, which lifted them up to market capitalizations and valuations that are quite lofty.

Based on 2014 estimated sales and growth, the following is a snapshot of the valuation of the three major social networking stocks.  While Price to Earnings (P/E) is a traditional valuation measure for stocks, since social networking stocks are at such an early stage of development and not very concerned about maximizing earnings, rice to Earnings (P/E) is not a good valuation gauge for these stocks.  Instead, it makes more sense to use Price to Sales (P/S) to develop an understanding of current and future valuations for these stocks.

The 2014 Estimated Sales, Price to Sales (P/S), and Estimated Sales Growth for the three major social networking stocks are as follows:

Facebook – Estimated Sales $10.38 billion, P/S 13.86, Estimated Sales Growth 36.1%

Twitter – Estimated Sales $1.13 billion, P/S 36.00, Estimated Sales Growth 76.5%

LinkedIn – Estimated Sales $2.16 billion, P/S 12.16, Estimated Sales Growth 42.4%

Based on their 2014 Estimated Price to Sales (P/S), Twitter appears to be overvalued compared to its peers in the sector, with a Price to Sales (P/S) that is approximately three times its two major competitors.  This is a valuation warning sign for Twitter investors.  Another negative for Twitter when comparing it to its two major competitors, is unlike Facebook and LinkedIn, Twitter is currently not profitable.  So, not only is Twitter trading at a much higher Price to Sales (P/S) valuation than its peers, but it is also not making money off of its revenues, so its business model can be considered unproven at this point.  The one thing that Twitter has going for it is the company’s Estimated Sales Growth is over 70% for 2014, which is considerably faster than its peers.  However, given its high Price to Sales (P/S) valuation, Twitter would have to maintain 70%+ sales growth for several years to justify such a high Price to Sales (P/S) valuation.

Are Social Networking Stocks Overvalued? | Alternative Stock Investments

If the valuations of the three major social networking stocks give you pause, keep in mind that there are alternative stock investments in the social networking space.  While the prospects for many of the secondary and tertiary social networking companies vary wildly, the whole sector should experience above-average growth for years, which may lift all boats within the sector.  Also, some secondary and tertiary social networking companies may be takeover targets of larger rivals or other companies trying to establish a presence in the space.  For example, in recent years, Facebook took over Instagram and Yahoo took over Tumblr.  For ideas regarding secondary and tertiary social networking stock investments, see Social Networking Investment Ideas.
Global X Social Media Index Exchange Traded Fund SOCL
To invest more broadly in the social networking sector, the Global X Social Media Index Exchange Traded Fund (ETF) (NYSE:  SOCL) provides exposure to the major social networking stocks and many additional social media and networking companies, including foreign social media and networking companies.


Are Social Networking Stocks Overvalued | This Risk of Owning Them

There are a number of risks associated with buying the big three social networking stocks at their current lofty valuations.  Of course, the primary risk is that the companies fail to deliver with the revenues and earnings that investors expect, and at some point the stocks have to readjust to lowered revenues and earnings expectations.  Another risk is that the social networking space becomes more fractured and the three major social networking stocks lose market share to competitors, which in turn will impact revenues and earnings going forward and consequently dampen their stock prices.  This is a real concern, as technology changes over time and the younger generations often gravitate to different products than their parents.  This trend is already evident with younger adults and teenagers that tend to prefer smaller social networking sites, such as Snapchat, over larger ones, such as Facebook, due to privacy concerns.

The history of technology stocks is littered with once-dominant companies that at one time commanded sky-high stock prices and valuations, only to see the carpet pulled out from under them, as technology and consumer preferences changed and caused their businesses to decline and their revenues and earnings to dry up.  As hard as it might be to envision right now, there is a real risk that some or all of the big three social networking stocks will someday lose their market share and public appeal to such an extent that their businesses go into permanent decline and their stocks follow suit.  Buyer beware applies to the big three social networking stocks.  As long as an investor is aware of the long-term risks of holding these stocks, they can properly calculate whether the potential long-term rewards outweigh the risks.

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