When it Comes to Social Media: "Don’t Believe the Hype"

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After Zynga (NASDAQ: ZNGA) beat the estimates of Wall Street with its recent earnings and is up sharply, investors should heed the advice of Chuckie D of Public Energy: “Don’t believe the hype.”

The social media sector consisting of companies such as Zynga, Groupon (NASDAQ: GRPN), Angie’s List (NASDAQ: ANGI), and FriendFinders Network (NASDAQOTH: FFNTQ) is lacking in one key ingredient: an economic moat, which protects the business model of a company from competition and time.

There is nothing in the business model of any social media company that comes remotely close to an economic moat. For Facebook (NASDAQ: FB), it membership of more than 1 billion is certainly formidable, but it is not an economic moat. There have been many articles about Facebook that predict it will go the way of MySpace. That certainly does not happen with companies that have a wide economic moat such as Coca-Cola (NYSE: KO) or McDonald’s (NYSE: MCD).

While there are articles discussing why Facebook will go out of business, it is already happening with Zynga, Groupon, Angie’s List, and FriendFinders Network. As the table below shows, the financials for each social media company are abysmal.

<table> <tbody> <tr> <td> <p><strong>Metric</strong></p> </td> <td> <p><strong>Facebook</strong></p> </td> <td> <p><strong>Zynga</strong></p> </td> <td> <p><strong>Groupon</strong></p> </td> <td> <p><strong>Angie’s List</strong></p> </td> <td> <p><strong>FriendFinders Network</strong></p> </td> </tr> <tr> <td> <p>Operating Margin</p> </td> <td> <p>10.57%</p> </td> <td> <p>(55.19%)</p> </td> <td> <p>4.41%</p> </td> <td> <p>(43.25%)</p> </td> <td> <p>14.86%</p> </td> </tr> <tr> <td> <p>Profit Margin</p> </td> <td> <p>1.04%</p> </td> <td> <p>(46.51%)</p> </td> <td> <p>(1.40%)</p> </td> <td> <p>(44.65%)</p> </td> <td> <p>(11.32%)</p> </td> </tr> <tr> <td> <p>Predicted Earnings Per Share Next Year</p> </td> <td> <p>38.60%</p> </td> <td> <p>(100.00%)</p> </td> <td> <p>41.18%</p> </td> <td> <p>44.90%</p> </td> <td> <p>n/a</p> </td> </tr> </tbody> </table>

Source: Finviz

There really is nothing offered by these social media companies that cannot easily be replicated by CraigsList, a newspaper, or another social media site. That is shown by how far each has fallen in share price. Facebook has fallen too, but it has bounced back due to the overreaction from its poorly executed initial public offering.

Those looking to profit from the social media sector should establish short positions when the share prices for companies like Zynga surge. Zynga is up 33.68% for the last quarter. As the stock is now around $2.90 a share, that is not much in price.

But it does leave room for a high percentage profit for a short position. When the price is that low, it is very difficult for a stock to recover. Trading is very sloppy. Institutions will avoid it due to their charter. Much of the action is the result of speculators and day traders, moving in and out, going both long and short.

Over the last year, the share price of Zynga is down by almost 80%. But is up almost 20% for the last week as earnings improved, beating what the analyst community was expecting. But Zynga is still losing money. The share price is off by 70% from the initial public offering price. Moreover, it is still losing money. And revenues were down 15%.

Volume is up sharply in recent trading for Zynga along with its share price. It is difficult to see how that can that upward trajectory can be sustained with revenues falling and the company continuing to lose money. Without an economic moat, the share price of Zynga should start to decline again, along with those for Groupon, Angie’s List, and FriendFinder Network.

Peter Harengel has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and McDonald's. The Motley Fool owns shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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