Opposite to what many might believe, Facebook Inc (NASDAQ:FB) and LinkedIn Corp (NYSE:LNKD) are not so attractive investments at the moment despite their market leading positions and strong brand names. What makes them unattractive is their valuations are sky-high. Yahoo! Inc. (NASDAQ:YHOO)!, instead, is pretty undervalued and deserves a closer look.
Below you will find the main reasons to back this hypothesis; you will discover that Yahoo! Inc. (NASDAQ:YHOO) could be a turnaround case after all, while Facebook Inc (NASDAQ:FB) and LinkedIn hold limited upside potential at their current valuations.
Facebook: One of the most important tech companies
Facebook Inc (NASDAQ:FB) used to be a buy case from almost any perspective. However, recently weak financial results, the exodus of hedge funds during the first quarter, and its valuation at over 500 times its earnings and 18 times the industry average,encourage a Hold recommendation at the time.
On the bright side, Facebook is one of the largest tech companies in the world and holds a globally recognized brand name. Moreover, its website’s traffic offers great value for advertisers since average users spend more time on Facebook Inc (NASDAQ:FB) than on any other website on the Internet. In addition, the company collects user information, from likes and dislikes to regular activities. This data is highly valuable for other firms and allows creating user-group-specific publicity.
Going forward, enterprise advertising budgets should continue to increase, largely benefiting Facebook. As a result, analysts expect an average annual earnings per share growth rate in the 26%-36% range over the next five years.
However, the rapidly evolving web environment poses several challenges to the firm. For starters, Facebook Inc (NASDAQ:FB) lost its display ad leadership to Google last year and the company’s dominance is expected to persist for a while yet. Furthermore, Facebook’s revenue strongly depend on its partnership with Zynga, which accounts for 15% of total revenue. Finally, two other concerns related to the future arise: that of the company’s founder holding a majority vote, pushing shareholders into the background in terms of decision-making; and the litigation and regulation risks related to Facebook Inc (NASDAQ:FB)’s control of massive amounts of personal data.
LinkedIn: Largest professional network
LinkedIn Corp (NYSE:LNKD) is another case of an overvalued stock inflated by exaggerated market expectations. Trading at over 500 times its earnings, more than 18 times the industry average, while offering margins and returns well below its peers’ mean figures, I’d recommend holding on this stock for now.
My main concerns revolve around a few subjects. For starters, competition is growing very fast and, although LinkedIn remains the largest professional network, other sites like Viadeo seem to offer better prospects in account of their penetration in emerging economies like China. Other major concerns derive from Facebook’s possible foray into the professional social networking segment and LinkedIn Corp (NYSE:LNKD)’s weak and seemingly permeable security system (which recently allowed a hacker to steal thousands of passwords and other data).
However, offering an expected average annual earnings per share growth rate above 50%, you should not lose track of LinkedIn’s stock. If its valuation became more reasonable, an attractive entry point would become available for long-term investors. If this were the case, shareholders can find reassurance in the substantial network effects from which LinkedIn Corp (NYSE:LNKD) benefits, plenty of expansion opportunities in a market that is far from mature, limited competition, high cash generation capabilities and a steady source of revenue derived from user subscriptions. Meanwhile, some analysts recommend shorting this stock, which doesn´t seem like a bad idea, taking into account the risk-reward ratio.