Growth at an Unreasonable Price
In investing, there’s a strategy known as GARP, which stands for growth at a reasonable price. In short, it relates to growth investors who look for companies showing strong underlying growth in revenue and profits whose shares still trade for reasonable multiples.
That last statement contains two important pieces: demonstrable growth, and a reasonable valuation. I believe Facebook Inc (NASDAQ:FB) has the former; the latter, however, just isn’t there.
Facebook earned one penny per share last year and $0.46 per share the year prior. Obviously a stock that earns one penny per share will have a ridiculous P/E. But, even on a forward basis, the valuation is lofty: Facebook trades for a forward P/E of nearly 50 times.
As far as LinkedIn Corp (NYSE:LNKD) is concerned, the company amassed a grand total of $0.19 per share in diluted earnings last year. That means that investors are paying more than 1,000 times 2012 earnings.
Like Facebook, LinkedIn and Yelp are both aggressively valued, even when you take strong future growth into account. LinkedIn and Yelp trade for forward P/E multiples of 90 and 230 times, respectively.
To be clear, I absolutely recognize the strong growth each of these companies is realizing currently. At the same time, valuations have risen so far, so fast, that even when assuming huge growth rates going forward, the odds of shareholders winning over the long-term aren’t in the investor’s favor.
These web sites undoubtedly have hundreds of millions of satisfied users and loyal fans. And, I can’t possibly say for certain that social media is the next bubble waiting to burst. What I will suggest, however, is that these stocks are not nearly profitable enough to justify the massive valuations they enjoy.
Facebook is now an $80 billion company by market capitalization. It’s rarely advisable to pay 50 times forward earnings for such a large company. These social media stocks are simply too risky for prudent long-term investors.
The article Should You Buy Social Media Stocks? originally appeared on Fool.com and is written by Robert Ciura.
Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Facebook and LinkedIn. The Motley Fool owns shares of Facebook and LinkedIn. Robert is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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