These Market Fads Will Underperform
Nikhil is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In the news nowadays, all you here about is the upcoming Facebook IPO, and how that will affect the world. With just 1 billion in bottom line, I don't think we should be expecting the outlandish valuations that people have been touting for Facebook to be 'fair value'. While it is a market that facebook has a virtual monopoly over (brand name will forever protect it from attempts by companies such as Google to take market share), Facebook will always have a hard time monetizing that monopoly, for fear of alienating its members. This difficulty is the primary reason why Facebook doesn't deserve the luxurious valuations it seems to be getting from the press and analysts.
Of course, there is a precedent now on the market for social networks: LinkedIn (NYSE: LNKD). LinkedIn is the facebook of the professional world. With users making LinkedIn a major way to connect to future employers, LinkedIn is transforming the way companies hire employees. Of course, post-IPO, Linked received an extremely high valuation from the market as well, shooting up to highs of $120 before settling down in recent months to stick around $75. Today of course, Linkedin stands at a remarkable $89.96, after flying up 17.76% post-earnings announcement. This, in my opinion, is a prime example of the insanity of the market. ABC news gave this as the reason: "THE SPARK: The company's fourth-quarter earnings, released late Thursday, made it clearer that LinkedIn's website has become an important hiring tool. And it stands to make even more money than it has been if employers continue to add jobs at the rate they have been in recent months. LinkedIn, which is based in Mountain View, thrived during the fourth quarter as its revenue more than doubled from the previous year, to nearly $168 million. The company also earned $6.9 million, better than analysts anticipated."
Linkedin also increased membership by 14 million to 145 million users in December 2011. "LinkedIn makes most of its money from the hiring services and other special privileges that it sells to headhunters and companies looking to fill positions. The company also sells advertising, but its most robust growth is happening in its hiring solutions division."
The thing about Linkedin is that unlike Facebook, it gets money from hiring services, allowing its increased membership to directly translate to profits. As unemployment drops, LinkedIn's profits should grow even higher. Of course, how high do they need to get? Within the last 3 quarters, 2 were profitable with a net profit margin of 4% and 3%. Assuming a 4% net profit margin, according to management's estimates of revenue at 860M in 2012, Linkedin should have earnings of 34.4M in net income in 2012. This gives Linkedin a forward P/E of only 252. And thats if management's expectations are met full on (it's extremely unlikely that there will be more growth than this in the next year). Yes, the market IS insane. And if LinkedIn, the more profitable and likely to succeed version is valued like this, then why should Facebook get valued higher?
Of course, market insanity just continues as Groupon (NASDAQ: GRPN) announced its earnings this quarter and promptly plunged (down 14% in the last 5 days). You know what's funny? I still hear about Facebook and Linkedin everyday as my friends and family use it...but Groupon? Does anyone even remember Groupon? Well, I'll certainly remember the 13.41 billion dollar market cap of today in a few years when the market catches up. The fad is leaving. The issue with Groupon is that its in an even worse situation than Facebook and Linkedin. It is overvalued like the both of them, and has trouble monetizing its business like Facebook. However, the biggest problems are that 1) It's not really even profitable, and 2) Unlike Facebook and Linkedin, there is no competitive advantage. No brand name. No economic moat. It really isn't too hard to replicate the effects of Groupon's business and remove Groupon from the equation. Schools do it all the time, calling restaurants and creating discounts in return for sending students there. Given, its not on the scale that Groupon has, and its not nearly as well organized, but the point is still there. In my opinion, Groupon has no competitive advantage.
And of course, this discussion ends on a more mellow note, with the overvaluation of Salesforce.com (NYSE: CRM). I actually respect Salesforce's business model, but the lack of strong profitability irritates me. Salesforce flirts with net loss every quarter, and sits at a P/E of 6151. Given, Finviz.com gives it a forward P/E of 80, much more reasonable than Linkedin, which is why I won't be making an underperform call on Salesforce. It's probably overvalued, but it might still be able to ride higher.
Yes, I am being a bit harsh, but I fully expect Groupon and Linkedin to underperform the market going forward. I'll make sure to give you the CAPScall to track my performance on these picks.
Motley Fool newsletter services recommend Salesforce.com. The Motley Fool owns shares of Salesforce.com and LinkedIn. shamapant has no positions in the stocks mentioned above. 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.