Which Social Media Heavyweight Is the Most Attractive Today?

Facebook (NASDAQ: FB  ) and LinkedIn (NYSE: LNKD  ) have been on a tear throughout 2013, with both doubling in valuation. Twitter (NYSE: TWTR  ) hasn't been public long, but since its IPO in November it has increased by 40%. Therefore, as we look ahead, which metrics can investors use to identify value in the space, and are any of these stocks still a buy?

How do you determine value in social media?
Anytime you look at a specific industry, you must realize that each space has its own drivers that determine upside and downside. For example, the catalysts for Procter & Gamble as not the same as those for Google, as one strives for efficiency while the other seeks growth.

In social media, the primary catalyst is overall revenue growth and the best indicator to assess value is a company's price-to-sales ratio. These are companies that aren't necessarily worried about margin growth and profitability, but instead are spending aggressively to gain market share and grow in emerging markets.

Therefore, revenue growth is a top indicator for the strength of a social media company, and since P/E ratios are meaningless with many of these stocks, the price-to-sales ratio becomes an important metric to determine what investors will pay to own a piece of these high-flying stocks.

Which stock is cheapest right now?
Not many investors buy social media stocks for their current fundamentals. Instead, investors are buying for future performance. Therefore, take a look at the chart below, and you'll see price-to-sales ratios based on 2014 expected growth.

Company

2014 Estimated Growth

2014 Estimated Sales

Price/2014 Sales

Facebook

36.1%

$10.38 billion 

13.86

LinkedIn

42.4%

$2.16 billion 

12.16

Twitter

76.5%

$1.13 billion 

36.0

As you look at the chart above, one company is likely sticking out: Twitter. So let's go ahead and end the suspense by saying that Twitter is in no way, shape, or form presenting the best value/growth opportunity based on revenue and valuation alone.

Twitter is approaching a multiple not seen since the dotcom era, and this fact should be worrisome to investors. First off, consider the fact that if next year's sales estimates are met for all three companies, then Twitter will have about half as much revenue as LinkedIn. Yet, right now, Twitter has a market capitalization that is 65% greater than LinkedIn. 

Allow those numbers to really sink in and then consider the high expectations that are being placed on Twitter to perform. Moreover, if we look at both Facebook and LinkedIn, assuming that 13 times next year's sales is the standard for social media stocks, then Twitter would need annual revenue of $3.13 billion to trade at the same premium, or present the same value as its peers. In other words, if Twitter maintains growth of 70% annually, which is unlikely given the fact that year-over-year growth naturally slows as a company grows larger, then Twitter is trading at 13 times 2016's revenue. 

While Twitter continues to soar to new highs almost daily, investors have to acknowledge that Twitter could very well underperform the market over the next several years or see a large pullback at some point in the near future. The expectations are simply too high; there is no room for error; and at 71 times trailing 12 month sales, there is very little upside remaining in shares of Twitter.

Lastly, investors might want to consider margins in their assessment of these three stocks. Because although margins are not the ultimate goal of social media companies at this stage in their business cycle, LinkedIn and Facebook are both highly profitable while Twitter has a negative operating margin of 25%.

With that said, LinkedIn is cheaper than Facebook and is also expected to grow faster. Both LinkedIn and Facebook have had exceptional years with better-than-expected top and bottom line growth. However, as we look ahead, LinkedIn is expected to have the better year, and is priced the cheapest of the three companies.

Therefore, one might conclude that LinkedIn looks like the slightly better opportunity from a valuation/growth perspective, while Twitter is without question priced above and beyond its peers.

Final Thoughts
Clearly, this is a fast-growing space, and if you want to capitalize on that growth while limiting risk then LinkedIn might be your best bet.

With that said, investors must acknowledge that social media is in fact a risky space, and that none of these companies are particularly cheap by normal market standards. Furthermore, if there's one thing the dotcom era taught us it's that there are far more Myspace-like companies versus Google.

Facebook may be well on its way to becoming the next Google, and it's possible that video advertising could boost total sales far more than analysts expect. However, anytime a social media company rolls out a new service it risks turning off users, which could then create significant selling pressure in the stock.

Therefore, when investing in social media stocks, keep its volatility in mind and realize the bullish expectations that are attached to nearly all of the public companies in this industry. While you might return large gains, those returns can also be lost. Thus, keep an eye on valuations as a way to gauge risk. Also, realize that just because LinkedIn is the cheapest today doesn't mean it will be tomorrow.

Hence, these companies must constantly be monitored.

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