Dear Valued Visitor,

We have noticed that you are using an ad blocker software.

Although advertisements on the web pages may degrade your experience, our business certainly depends on them and we can only keep providing you high-quality research based articles as long as we can display ads on our pages.

To view this article, you can disable your ad blocker and refresh this page or simply login.

We only allow registered users to use ad blockers. You can sign up for free by clicking here or you can login if you are already a member.

Facebook Inc (FB), LinkedIn Corp (LNKD): Why Social Media Valuations Are Irrationally High

The IPO classes of 2011 and 2012 include Facebook Inc (NASDAQ:FB), LinkedIn Corp (NYSE:LNKD), and Yelp Inc (NYSE:YELP). While their initial offerings experienced varying degrees of success, the investing thesis behind each of them remains the same. The financial media touts these companies as the next great growth plays, sure to provide great wealth to their shareholders. But investors who focus on these companies’ intrinsic value will likely reach a different conclusion.

Brace yourselves for a bumpy ride

Facebook PhoneAfter perhaps the most closely watched IPO of all time last year, the excitement surrounding Facebook Inc (NASDAQ:FB) quickly turned to despair. Investors saw the company’s share price collapse from $38 to $17 in four months.

Fortunately for investors, the stock has recovered to its current level of $27 per share on optimism surrounding the company’s expanding user base and mobile operations. As of its 2012 annual report, Facebook had more than 1 billion monthly active users worldwide.

LinkedIn Corp (NYSE:LNKD) is something of a Facebook Inc (NASDAQ:FB) for professionals. The company’s namesake networking platform allows busy professionals to connect with each other and search for jobs. The website boasts more than 200 million members, and the stock has performed better than any other social media stock by far since its IPO. Shares of LinkedIn Corp (NYSE:LNKD) are almost double where they were after their first day of trading.

Yelp Inc (NYSE:YELP), meanwhile, is an online guide for information and reviews of places of interest; it went public a little more than one year ago. Though Yelp’s stock soared 64% in its first day of trading, it’s returned very little since. The stock ended its first day at $25 per share, exactly where it exchanges hands today.

Profitability matters (or at least it should)

The market calls these companies disruptive, transformational, and innovative marvels. Unfortunately for investors, they’re also barely profitable.

Investing isn’t about which businesses are the sexiest ideas. Most of the best-performing stocks over time have come from industries that are anything but sexy. To be successful over the long term, it’s pivotal that investors select profitable businesses trading for less than they are intrinsically worth.

Consider that Facebook Inc (NASDAQ:FB) generated more than $5 billion in revenues last year, up from $3.7 billion the year before. While 37% revenue growth sounds fantastic, it becomes less so when you realize that Facebook’s expenses more than doubled over the same time period. As a result, Facebook’s diluted earnings per share fell from $0.46 in 2011 to one penny per share last year. That means that current investors are paying more than 2,600 times the company’s fiscal 2012 profits.

LinkedIn Corp (NYSE:LNKD) and Yelp Inc (NYSE:YELP) also carry eye-popping valuation multiples. In 2012, LinkedIn’s revenue increased 86% to $972.3 million, from $522.2 million the year prior. Additionally, diluted EPS increased to $0.19 from $0.11 year over year. At its current price of $178 per share, an investor is paying more than 930 times trailing diluted earnings.

Yelp, meanwhile, isn’t profitable, despite 65% revenue growth in 2012. The company reported a $19 million net loss last year, amounting to $0.35 per share, which did represent an improvement from the $1.10 per share loss from the year prior. The company’s CEO called 2012 “a tremendous year for Yelp” in the company’s earnings announcement, but I’m not sure most of Yelp Inc (NYSE:YELP)’s investors agree with that assessment.

DOWNLOAD FREE REPORT: Warren Buffett's Best Stock Picks

Let Warren Buffett, George Soros, Steve Cohen, and Daniel Loeb WORK FOR YOU.

If you want to beat the low cost index funds by 19 percentage points per year, look no further than our monthly newsletter.In this free report you can find an in-depth analysis of the performance of Warren Buffett's entire historical stock picks. We uncovered Warren Buffett's Best Stock Picks and a way to for Buffett to improve his returns by more than 4 percentage points per year.

Bonus Biotech Stock Pick: You can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12 months.
Subscribe me to Insider Monkey's Free Daily Newsletter
This is a FREE report from Insider Monkey. Credit Card is NOT required.