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Wall Street's Newest Bubble

By Matthew Argersinger - Updated Apr 6, 2017 at 9:34PM

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See which arena is set to pop.

Wow. That was my initial reaction back in January to Goldman Sachs' (NYSE: GS) $450 million investment in Facebook, which implied a $50 billion market valuation for the popular social-networking site. When a follow-up investment last week established a new $65 billion valuation, my response had a slightly more McEnroeian bent: You cannot be serious!

In less than 10 years in existence, Facebook's market value has surpassed that of iconic corporate giants such as Boeing (NYSE: BA), Honeywell (NYSE: HON), Kraft (NYSE: KFT), and Nike (NYSE: NKE).


Market Cap

12-Month Revenue

12-Month Free Cash Flow

Facebook (estimated) $65 billion $2 billion ??
Boeing $54 billion $64 billion $1.8 billion
Honeywell $47 billion $33 billion $3.6 billion
Kraft $55 billion $49 billion $2.1 billion
Nike $36 billion $20 billion $2.1 billion

Each company generates tens of billions in annual sales and has almost impenetrable competitive advantages built from decades upon decades of growth. More importantly, these companies will be here tomorrow, next month, next year, and in the next decade -- still producing great products, expanding into new markets, and churning out loads of free cash flow.

Facebook ... well, it has a "poke" feature.

A social-networking bubble?
And it's not just Facebook. An investment in Twitter by JPMorgan Chase (NYSE: JPM) last month valued the 5-year-old social microblogger around $4.5 billion. Popular job networking site LinkedIn recently filed for an initial public offering that values it around $2.5 billion. (Through the first nine months of 2010, LinkedIn reportedly generated a mere $10 million in profits.) And then there's the rumored $10 billion valuation for Zynga, the social-gaming company responsible for the megahit Farmville, and Groupon, the popular deal-of-the-day website, which some have valued in the $15 billion to $20 billion range.

I don't know about you, but these valuations seem a tad bit outlandish to me. Today's zeal for social-networking sites harkens right back to those bubbly dot-com boom days from the late '90s. You remember those, right? Wall Street made billions on IPOs of profitless technology and dot-com companies. Remember How about Webvan? One of the most egregious in my opinion: VA Linux Systems. Check out this language from the "Internet infrastructure" company's 1999 IPO prospectus:

We do not expect to generate sufficient revenues to achieve profitability and, therefore, we expect to continue to incur net losses for at least the foreseeable future. If we do achieve profitability, we may not be able to sustain it.

Classic, right? Well, that language wasn't enough to dissuade investors from driving shares of the company up 700% on their first day of trading to a high of $320 per share, awarding Linux with an incomprehensible market cap of nearly $13 billion! Not bad for a company that didn't expect to generate any meaningful profits in the foreseeable future.

A short time later, in July 2002, shares of VA Linux traded hands at $0.54.

Many individual investors bought the hype that Wall Street was selling and were left holding the bag when the dot-com bubble burst. No matter for Wall Street. By then, it was well on its way to its next money-making, er, losing, gig: subprime mortgages. We all know how that story ended.

Don't chase the hype
There's going to be some huge winners in the social-networking space, no question. But attempting to pick the ultimate winners in an industry with extremely low barriers to entry will be an exercise in futility. Individual investors who blindly chase after these stocks following their IPOs are taking the same risks their dot-com-chasing counterparts took more than a decade ago. In most cases, it will lead to damaged portfolios and more than a few tears.

When asked in a recent interview on CNBC why he doesn't invest in some of the faster-growing technology names, Warren Buffett responded:

I understand things that happened in the past and which ones are likely to repeat and which ones are hula hoops or pet rocks. I can make those decisions reasonably well. I am not good at listening to 20 guys who've got great new ideas about things that are going to change the future.

Investing in the past may not be as glamorous as betting on what could be the next Facebook, but in our view, it's a much more prudent way to profit in the future.

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Stocks Mentioned

Kraft Foods Group, Inc. Stock Quote
Kraft Foods Group, Inc.
JPMorgan Chase & Co. Stock Quote
JPMorgan Chase & Co.
$117.32 (2.98%) $3.40
The Goldman Sachs Group, Inc. Stock Quote
The Goldman Sachs Group, Inc.
$302.75 (5.79%) $16.58
The Boeing Company Stock Quote
The Boeing Company
$141.53 (5.64%) $7.56
Honeywell International Inc. Stock Quote
Honeywell International Inc.
$180.02 (3.12%) $5.45
NIKE, Inc. Stock Quote
NIKE, Inc.
$112.91 (4.55%) $4.91

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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