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LinkedIn Leading the Way to Next Tech Bubble

Long-term investors have no business buying this stock

Haven’t we been through this before?

The latest wave of planned Internet stock offerings has brought with it a level of manic investor behavior last seen in the infamous Internet bubble of the previous decade. We haven’t seen any sock puppets yet, but something similar could be coming to a computer near you.

We’re talking, of course, about LinkedIn (NYSE: LNKD). The networking site operator saw its market cap soar to nearly $9.5 billion last week after another $5 jump in its share price. At its Friday close of $99.60, the stock was trading at a trailing P/E of 1,144x, a forward P/E at a comparatively reasonable 255x, and a price-to-sales ratio of over 30. LinkedIn shares added another $1.31 Monday, ending the day at $100.91 after trading as high as $104.45.

Naturally, investors aren’t just paying for LinkedIn’s current earnings. The hope among bulls is that the company is going to do nothing less than revolutionize the entire employment placement industry. With no solid evidence available to prove this thesis yet, the stock is levitating based simply on the “story” — an echo of what drove many stocks into the stratosphere during the original Internet bubble.

Last week, the stock’s valuation came under attack from Capstone Investments analyst Paul Meeks, who initiated his coverage with a sell rating and $45 price target. Citing “froth” in the stock price, Meeks questioned whether LinkedIn was worth its lofty price given the questions about its scalability, competition and business model. Not least, he questioned the company’s accounting practices and corporate governance. All valid points, but — true to form for a classic bubble stock — the shares barely budged on the news.

If Meeks is right, what’s driving the stock higher? The issue right now is one of scarcity. The current float, at 7.82 million shares, is a fraction of the 94.5 million shares outstanding. Add to this the fact that the shares short equal about 30% of LinkedIn’s float, and you have the recipe for the 67% rally in just the past 14 trading sessions. Another factor likely driving the stock is that the most hotly anticipated social-networking IPOs still to hit the market — Twitter, Facebook, LivingSocial, Groupon, et al — cannot yet be traded by those looking to make a play in this space.

The question, of course, is how to make money with LNKD? The stock is essentially a trading vehicle at this point, so it offers opportunities for intrepid investors willing to go against the grain after extreme moves. As the year progresses, the best trade with LinkedIn probably will be to step up and buy on the occasions when the stock gets trounced like it did in early June. With the short interest as high as it is, LNKD will give you plenty of chances to grab 20%-50% of quick upside regardless of its valuation.

Ultimately, however, the valuation is telling us that betting against LinkedIn is the only trade to make right now. We’ve seen this story before, after all. Shorting LNKD isn’t an option, since there aren’t any shares available to borrow.

Investors must therefore turn to put options, but extreme caution is in order due to the massive implied volatility. For example, if you want to bet that the stock will be cut in half by September, you’ll have to shell out about $1.50 for the Sept. 45 puts. Such a large move isn’t without precedent, however — the stock did in fact fall 50% in one month, from an intra-day high of $122.43 on the day of the IPO (May 19), to $60.14 at its low on June 20.

The best answer is to take the (relatively) safe approach of buying September put options in the $80-$90 strike price range. This provides a cushion — 68 calendar days — to absorb the hit from an additional short squeeze, while at the same time providing plenty of room to profit from a downside move in the stock in the interim. It’s always a smart choice to use stops when trading options, and that’s particularly true for an exceptionally volatile stock such as LinkedIn.

The bottom line: Trading LinkedIn is playing with fire and absolutely not for the faint of heart. But in the long run, it’s inevitable that this stock will punish those who elect to buy at these levels.

Article printed from InvestorPlace Media, https://investorplace.com/2011/07/linkedin-lnkd-stock-bubble/.

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