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When it Comes to Social Media: “Don’t Believe the Hype” – Zynga Inc (ZNGA), Groupon Inc (GRPN)

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After Zynga Inc (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 Inc (NASDAQ:GRPN), Angie’s List Inc (NASDAQ:ANGI), and FriendFinder Networks Inc (NASDAQ:FFN) is lacking in one key ingredient: an economic moat, which protects the business model of a company from competition and time.

Zynga Inc (NASDAQ:ZNGA)There is nothing in the business model of any social media company that comes remotely close to an economic moat. For Facebook Inc (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 The Coca-Cola Company (NYSE:KO) or McDonald’s Corporation (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.

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

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.

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