3 Reasons Social Media Stocks are Falling

by James Brumley | May 5, 2014 9:28 am

The past few weeks have been nothing less than miserable for social media stocks like Twitter (TWTR[1]), LinkedIn (LNKD[2]), Facebook (FB[3]), and Yelp (YELP[4]).

social media stocksShares of TWTR stock have fallen 46% since late December. Facebook is down 16% from its early-March peak. LinkedIn has made a string of lower lows since September, hitting a multi-year low last week to bring the total tumble to 42%. And Yelp is still down 39% from its early-March high, despite a recent uptick.

With losses that large and that widespread, it would be naive to chalk them up to “just a little volatility.” This is something systemic, and something the market feels very strongly about — completely reversing the bullishness surrounding all of these names not too long ago.

What gives? And more importantly, can the selling be reversed before TWTR, YELP, LNKD, and FB stock are beaten down to the point of no return?

Here’s a look at why social media stocks are falling.

Guilt by Association

social media stocks, twtr stockIt hasn’t been admitted or acknowledged by most investors, but the reality is, weakness from TWTR stock is the biggest reason most other social media stocks have tanked during the past four months.

As the saying goes, where there’s smoke there’s fire. If the Twitter growth rate is slowing, then investors easily conclude — errantly or not — that companies in comparable businesses are similarly suffering. And as it turns out, Twitter’s growth is slowing.

The number of active Twitter users grew at a slower pace in the first calendar quarter of 2014, on a quarter-to-quarter basis as well as on a year-over-year basis. Specifically, the social media site only added users at a pace of 25% (YOY) last quarter[5], versus a growth rate of 30% (YOY) two quarters ago. Compared to the fourth quarter of 2013, the number of active users Twitter added only grew by 6%. If Twitter can’t maintain its pace, then surely Facebook and LinkedIn are in the same trouble.

It’s an issue because the red-hot growth rates are the core reason traders were willing to pay such a sharp premium for these stocks. Speaking of which…

Social Media Stocks (Still) Boast Crazy Valuations

social media stocks, lnkd stockAn extension of reason No. 1, those lofty valuations don’t make nearly as much sense if growth rates are falling fast. And, even with the big pullbacks in the value of YELP, LNKD, and both of the other major social media stocks, valuations are still relatively insane.

Forget the lack of earnings — traders are willing to bet those will come later. Even solely on a revenue basis, these stocks are still priced well in excess of the “normal” price/sales ratio of around 1.7[6]. LNKD is currently trading at a price-to-sales ratio of 11.63… five times the market’s average. TWTR is trading at a price/sales ratio of 27.8. And YELP is priced at a trailing P/S of 17.3.

Even if margins improve by leaps and bounds in addition to a massive increase in revenue, these stocks are still going to mathematically have a nearly-impossible time justifying their current values to any reasonable investor.

The only one of these for social media stocks that even comes close to justifying its current price is FB stock, and it’s still pushing its luck. As of the latest look, Facebook shares are trading at a trailing P/E of 78.4, and a forward-looking P/E of 33.0. Investors have seen (and bought) worse — and to be fair, Facebook’s year-over-year revenue grew by 72% last quarter[7], on the heels of big growth on the mobile-advertising revenue front. Even then, though, there doesn’t appear to be much room for an encore.

The Euphoria is Wearing Off for Social Media Stocks

social media stocks, fb stockPerhaps an extension of reason No. 1 and reason No. 2, the social media “trade” is getting a little boring for investors. For a trade that relies more on hype than substance, it’s the worst thing in the world.

Past examples of the boom-bust cycle include dot-coms in the late 90s and early 2000s, oil between 2007 and 2009 (real estate, too), gold between 2011 and 2013, Chinese stocks between 2007 and 2008 … and plenty others. When each of those groups was peaking, investors were sure they’d never stop rising.

Nothing lasts forever though, and sure enough, all of these groups eventually got trashed. Each of those categories of stocks is still around, but the market just wasn’t as interested the second time around when they started to recover. Social media stocks are apt to fall into that same trap.

It’s not a matter of value, either — many of the aforementioned industries and groups are performing better now than they were when their stocks were going ballistic. It’s mostly an innate investor desire to always remain on the hunt for the next big thing.

Bottom Line

social media stocks, yelp stockThis doesn’t mean that none of these stocks can never rally again, nor is it to say that all of these companies are doomed. It is to say, however, that most investment crazes only ignore the fundamentals once in their lifetime, but once investors realize these stocks aren’t infallible, the market never seems to be able to fall in love with them the same way again.

In other words, the best “do-no-wrong, buy-em-just-on-the-premise” days for social media stocks are likely behind them. From here, traders are apt to hold them to higher, performance-based standards. That’s going to make life considerably tougher for all them.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:

  1. TWTR: http://studio-5.financialcontent.com/investplace/quote?Symbol=TWTR
  2. LNKD: http://studio-5.financialcontent.com/investplace/quote?Symbol=LNKD
  3. FB: http://studio-5.financialcontent.com/investplace/quote?Symbol=FB
  4. YELP: http://studio-5.financialcontent.com/investplace/quote?Symbol=YELP
  5. the social media site only added users at a pace of 25% (YOY) last quarter: https://investorplace.com/2014/04/twtr-stock-twitter-earnings-fatigue/view-all/
  6. the “normal” price/sales ratio of around 1.7: http://www.multpl.com/s-p-500-price-to-sales
  7. grew by 72% last quarter: http://www.sfgate.com/technology/article/Facebook-profit-soars-on-ad-revenue-growth-5425554.php

Source URL: https://investorplace.com/2014/05/social-media-stocks-fb-twtr-yelp-lnkd/