Facebook Inc (NASDAQ:FB) has fallen 50% from its IPO price. Zynga is doing even worse, and might not be able to survive as an independent company. Groupon still isn’t profitable- at least the way that any normal company would calculate profits- and is down 82% from its own IPO price. And now it’s looking like we may be experiencing more than the popping of a social bubble, with Google Inc (NASDAQ:GOOG) and Microsoft Corporation (NASDAQ:MSFT) both reporting disappointing earnings last week; Google’s poor results sent the stock tumbling about 10% on the day. Read about Google’s bad quarterly report.
Compare the poor performance of these companies to the rebound taking place on maligned Wall Street. So far in earnings season, Morgan Stanley, Goldman Sachs, JPMorgan Chase, Bank of America Corp (NYSE:BAC), and Citigroup Inc. (NYSE:C) have all beaten expectations, some by substantial margins. And this comes after their stock prices have soared this year: now, Morgan Stanley is up by 15%; JPMorgan Chase about 25%; Goldman and Citi by about 40%, and Bank of America’s stock by 70%. Read our most recent analysis of many of the most frequently owned banks.
So why is the Street trouncing the Valley (and Redmond)? Whatever the reason, it doesn’t seem to be something that hedge fund managers perceived. Citigroup, Bank of America, and JPMorgan Chase all made our list of the ten most popular stocks among hedge funds for the second quarter of 2012, but they weren’t as popular as Google Inc (NASDAQ:GOOG) or Microsoft (see the full ranking of the most popular stocks).
The argument can be made that many of the technology companies’ problems are company-specific. Arguably, Groupon was always a bad business model, with investors only realizing that fact after its IPO; Zynga was doing quite well until Facebook Inc (NASDAQ:FB) altered the layout of its website and choked off much of the company’s user base; Microsoft’s customers are waiting for new versions of the Windows and Office software, earnings will pop next year. And it’s certainly true that part of the reason for Facebook Inc (NASDAQ:FB)’s decline was that its share price had been bid up by glamour investors who were seduced by its usership numbers. However, we think that particularly with Google Inc (NASDAQ:GOOG)’s results some of the decline at some of these companies is coming as businesses decide that online advertising is not a good investment, driving down advertising rates.
At Google Inc (NASDAQ:GOOG), for example, cost-per-click revenues fell 15% in the third quarter compared to Q3 2011. This can’t possibly be good news for Facebook Inc (NASDAQ:FB) either, and we’ll keep an eye on its revenue numbers when it releases its quarterly report on October 23rd. In addition, the new environment of mobile Internet usage has provided a challenge for advertisers who have spent the last several years designing their strategies for traditional PC usage. It’s certainly possible that Internet companies will devise ways to serve mobile ads alongside content that delivers good value to users and customers, but it at least should take time. We also think that the barely profitable Groupon is failing to offer good marketing services to its customers, and we’re skeptical that further growth will fix that problem (though we’d note that at a forward P/E of 13 we’re in disagreement with sell-side analysts on that point). Zynga was barely profitable in its prime, when it dominated Facebook gaming, and was likely overvalued then; at some point its cash makes it attractive, but we’d still avoid the stock.
At the banks, meanwhile, interest rate dynamics have provided cheap money to finance trading operations (as well as a wider spread on the interest rate that the banks with retail operations have to pay their depositors) which have offset struggling investment banking fees. The Federal Reserve has committed to keeping interest rates low for some time, and even outside Fed involvement an uncertain global economic environment will contribute to low rates. Citi and Bank of America still trade at substantial discounts to the book value of their equity, and at forward P/E multiples of 8 and 10, respectively. As such, they are considerably cheap; while we do think Bank of America may be struggling enough to make needed cost cuts that we wouldn’t buy the stock at this point, we do still see Citi as a value play. JPMorgan Chase and Goldman Sachs are also in the 8-10 range in terms of forward P/Es, and with good growth in the third quarter over Q3 2011 they could be good values as well.
Our impression is that Facebook (NASDAQ:FB), Zynga, and Groupon may have stabilized for now, but still aren’t good values by any means. Google Inc (NASDAQ:GOOG) and Microsoft (NASDAQ:MSFT) don’t look particularly expensive, but are dependent on advertising revenue and successful product releases respectively. It looks like the banks are still better buys than the big-name technology and Internet companies.