Investor reaction to each of these earnings reports tells a mixed story: Shares of LinkedIn and Twitter both rose by more than 10% – shares of Yelp fell by more than 20%.
Prior to these social media earnings reports, each of the three stocks traded at sky-high valuations, so there was huge potential for wild swings in share price.
Interestingly, Yelp suffered the biggest decline in share price but was – and still is – the cheapest of the group. But “cheapest” is a relative term, as each of these stocks trades at valuations that seem insane to me.
Yelp’s shares traded at a forward price-to-earnings (forward P/E) ratio of 52.95 before Friday’s decline of more than 21%. Today shares trade at a forward P/E of around 41.
Twitter’s stock traded at a forward P/E of 62.43 before it jumped higher by just over 16% on Friday. Today it trades at a forward P/E of around 70.
LinkedIn is the most expensive stock of the social media stocks. Shares of the social network for professionals traded at a forward P/E of 63.98 prior to its jump higher of nearly 11% on Friday. Today LinkedIn trades at a forward P/E of around 73.
To give you some context for how ridiculous these valuations are, Apple (NASDAQ: AAPL) trades at a forward P/E of 12.7. Even by the standard set by social media giant Facebook (NASDAQ: FB), the stocks mentioned above are tremendously expensive – Facebook trades at a forward P/E of 30.
Let’s take a closer look at the earnings reports for each company.
Twitter was the biggest gainer in the group. The stock jumped more than 16% after the company announced a 97% revenue increase in the fourth quarter of 2014 compared to the fourth quarter of 2013, rising to $479 million. Analysts had only expected revenue of around $451 million.
The company also reported strong results for 2014 as a whole. Revenue jumped to $1.4 billion, up 111% compared to 2013. It also expects revenue to jump another 66% in 2015 to roughly $2.3 billion.
I remain highly suspicious of Twitter’s valuation. The stock is more than five times as expensive as Apple on a forward P/E basis but its user acquisition growth continues to slow considerably, as illustrated in the chart below.
As the only social network that has been widely adopted by professionals, LinkedIn dominates its niche. It also dominated earnings in 2014.
The company reported fourth-quarter revenue of $643 million, up 44% from the fourth quarter of 2013. Analysts had been expecting revenue of around $617 million. Revenue for the full year was strong as well, rising to $2.2 billion, a gain of 45% compared to 2013.
LinkedIn is different than most social media companies in the sense that it isn’t heavily reliant on advertising revenue. It generated only 24% of its revenue from advertising in the fourth quarter, compared to 19% generated from premium profile subscriptions and 57% generated from “talent solutions.”
“Talent solutions” are services through which LinkedIn makes it easier for recruiters to find and communicate with qualified candidates. Facebook, Twitter and Yelp simply don’t offer these kinds of services.
Despite this clear advantage and LinkedIn’s strong revenue growth, the stock is simply too expensive. It, too, is more than five times the price of Apple and wasn’t profitable in 2014.
The primary reason Yelp’s shares fell by more than 21% on Friday is that investors are worried that growth is slowing down – and for good reason.
The chart below illustrates the decline of unique users, both desktop and mobile users. Desktop users had been on the rise until the first quarter of 2014 while mobile users were on the rise until the third quarter of 2014.
The company also announced that it would triple its marketing expenses.
A falling user base and rising marketing expenses sure look to me like a downward spiral. Yet the stock still trades at a forward P/E of 41 and a P/E of 95, a valuation that makes no sense for a business with important metrics moving in the wrong direction.
These social media earnings reports offered a mixed bag but one thing is consistent across the board: valuations are out of control. I personally think Twitter has become an indispensable part of how the world communicates but has yet to demonstrate how it can be profitable enough to support its valuation. Yelp seems relatively pointless to me, as barriers to entry on customer review services are alarmingly low. LinkedIn offers tremendously valuable services to professionals, job seekers and recruiters.
But even shares of LinkedIn – the gem of the group – are entirely too expensive. I would avoid the whole group.
DISCLOSURE: I personally own shares of Apple.
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