Social Media Is a Foolish Bet

 | Jul 31, 2014 | 4:00 PM EDT
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Earlier this month Stanley Druckenmiller was on CNBC's Delivering Alpha show, and he had some interesting remarks regarding the economy and the markets. Since he is reported to have earned something close to 30% per year for many years, his opinion must be one to which you listen closely.

One remark Druckenmiller made may end up as tattoo or a nice stitched wall hanging around Chez Melvin in the future. When discussing the Federal Reserve's policies and eventual outcome of ending stimulus and low interest rates on U.S. Treasuries, he admitted that he had no idea how things would end. We might even get lucky and get out of this without a disaster. But he said that, even if that were to happen, it wouldn't have made that a good bet: "What I am sure is, they're making a bad bet, a bad risk-reward. So you could go to the lottery and you could win the lottery, but it doesn't mean it was a good bet."

Although he was talking about the Fed and the economy, I think you can apply this same logic to the social-media stocks. Now I do realize that, when it comes to the price direction of these stocks -- and with the exception of LinkedIn (LNKD) -- the market has been right and I have been wrong. These shares have just continued to power higher amid investors' excitement about all those eyeballs, tweets, posts and advertisements enjoyed by social-media companies.

Perhaps these companies will continue to grow to the moon, and the stock prices will go ever higher. It could happen -- but that does not mean it's a good bet from this level.

I use social media often. I am a big fan of Twitter (TWTR), as I can use it to share articles and ideas in quick bursts and post snarky comments in 140 characters or less about the events of the day. I have connected with old friends on Facebook (FB) and check it a few times a day. My wife is something of a Yelp (YELP) addict and is constantly using it to find new eateries and services.

However, if I am realistic, I could easily live without it -- and I suspect social media subtracts more from society as a whole than what it adds. Even if I were willing to say that social media is the greatest addition to the world since the printing press, I still would not be able to justify a bet based on these valuations.

Twitter added something close to $5 billion in market capitalization this week after it announced earnings that surpassed expectations. Given its trailing-12-month sales of $801 million, I am not sure I can work a rational case that Twitter is worth even $5 billion, to say nothing of its current $27 billion market cap. The company is losing money, and it trades for more than 170x what Wall Street hopes it will earn next year. Twitter may ride the mo-mo wave higher as the storytellers convince investors to continue with a rousing game of pass-the-match, but that doesn't make it a smart bet.

As for Facebook, its capitalization is now higher than that of companies such as AT&T (T), Coca-Cola (KO), Pfizer (PFE) and Disney (DIS), even though Facebook brings in a fraction of the revenue and profit of these blue-chip companies. I am on Facebook twice a day or more, and I have never clicked an ad or bought a product off the site. I have run several ad campaigns on the site with horrible results, as well, so I can't be the only one who doesn't respond to the ads and promotions.

This stock is trading at almost 20x sales, 87x trailing earnings and almost 40x what analysts hope it will make next year. Facebook is cool, but is it really worth more than Eli Lilly (LLY), Ford (F) and Brookfield Asset Management (BAM) combined?

You can walk through the numbers on the other social-media stocks, as well. If you do you'll see that, even if the market keeps taking these shares higher in the short term, it simply would not be a smart bet. LinkedIn trades for 13x sales and is unprofitable. The forward price-to-earnings ratio on hoped-for earnings is 175x. Yelp is at 20x sales and 240x what the analysts wish they will earn next year. There is no rational valuation scenario I can imagine that will make these stocks worth these numbers.

Would I short these stocks right now? No -- I am overly fond of my face and would prefer not to have it ripped off by a pack of marauding momentum traders. If I were fortunate enough to have owned them this year, I would now be offloading as quickly as I were able. There are no circumstances under which I would be a buyer right now, as the valuations are all hopes and dreams at this point. That does not make for a smart bet.

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