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Social Media Stocks: What to Know, What to Look For, and What to Avoid

  +Follow January 21, 2014 9:05AM
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Facebook__2_.jpgTen years ago, LinkedIn (LNKD), Facebook (FB), and Twitter (TWTR) didn’t even exist. Today they are collectively worth over $175 billion. And there’s scores of other social media businesses right on their heels, as well as established players like Google Inc. (GOOG) trying to get in on the action.

In such a young, volatile market, picking social media winners can seem like a crapshoot. But even though the market is still being developed, it’s not impossible to see what makes some social media plays successful and others tank.

If a social media company is to succeed – not in the seed stages, but after the IPO as well – they must abide by a few commandments, and investors should be wary of social media companies that do not abide.

Social Media Stock Commandment #1:

The majority of revenue must come from mobile.

As the nature of accessing the net evolves, investors more and more like companies that get most of their engagement via mobile. Whether high mobile usage is merely code for “young users” or “addicted users” is probably not important because they’re essentially the same. But a social media company from 2013 onwards cannot expect to stay relevant if a sizable portion of their users aren’t getting on via their phones and tablets.

And of course, they should be monetizing their mobile users, or at least have plans to do so soon. Facebook was long dogged by this problem, with a lack of mobile revenue holding the company back after their disastrous May 2012 IPO. Facebook solved that problem in 2013, as their triumphant second quarter earnings report showed. Twitter, for its part, has always been at home at mobile. 75 percent of users access the site from a phone or tablet, and that number is sure to increase.

Social Media Stock Commandment #2:

The company must project rapid revenue growth, or the company will get compared in the media to MySpace.

This is part of the reason that in late 2013 Twitter experienced such a surge. While they lacked much revenue history at all when they went public, their projections excited investors greatly. The company predicted that revenue would grow from $316 million in 2012 to $807 million in 2014. Investors liked this very much, partially explaining the 75 percent gap Twitter experienced at their IPO.

Contrast this with Facebook. Like any large company, the $110 billion market cap Facebook is reaching market saturation. Simply put, when you’re already huge it become harder and harder to ratchet high percentage growth. This made investors a little more wary of Facebook at the close of 2013. Ditto for LinkedIn, who after consistently beating analyst expectations had to dial back their projections in late 2013, which sent shares tumbling for the first time in years.

Social Media Stock Commandment #3:

The company must stay relevant with young users, or the company will be labeled “uncool.” This is a social media company’s death knell.

In their third quarter 2013 earnings report, Facebook reported exceptional revenue and earnings. But still their stock tanked. Why? In the conference call following the earnings report, Facebook’s CFO made a passing comment about how teenagers made up a smaller percent of users than ever before. The CFO’s little admission turned a 15 percent upswing (caused by an increase in mobile revenue) to a one percent drop.

In short, the CFO had admitted that Facebook was in danger of not being cool. Like the traditional entertainment industry, social media thrives on “the demo,” or the customers between 18 and 39 that are most coveted by advertisers. With social media, it could be argued that the demo skews even younger. Perhaps the hottest still-private social media company, Snapchat, has wowed investors in large part because of its massive popularity with the 12-18 set.

Social Media Stock Commandment #4:

The company must target advertising, or they will fall to the wayside.

One of the things advertisers love about social media is that it encourages users to self-profess their own demographics. And thus, it makes it much, much easier to throw advertising at users that actually might be of interest to them.

Targeted advertising is more effective, which means companies can charge more to run it. It’s partly a case of necessity. After awhile, large social media companies like Facebook invariably begin to reach market saturation. When you’ve already got over a billion users, where do you go from there?

The answer is you get more money out of the users you already have, via well-targeted ads. This explains why Twitter popped 6 percent when they unveiled a new tailored advertising product named, um, Tailored Advertising. As social media is able to better understand their users’ unique tastes, they can throw ads at them that can have a greater effect, and, in turn, can generate more revenue.

Social Media Stock Commandment #5:

The revenue stream shall have many branches. Revenue diversification pleases the social media investor.

In his analysis of Twitter pre-IPO, Equities.com IPO expert Francis Gaskins praised the company for its diverse revenue streams, noting that it already possessed three main drivers and had eight more in the works. Diversification helps ensure that if one aspect of the social media empire becomes “uncool” (gasp!) then another can begin to pick up the slack. For instance, Gaskins was impressed with Twitter’s video app Vine, which is both popular with young users and tailor-made for delivering short advertising bursts.

LinkedIn, for their part, has always maintained a healthy diversification, offering three revenue streams to ensure a steady flow of capital. And Facebook – oft derided for being too reliant on the mother platform – has made some smart acquisitions in the past couple of years, most notably Instagram for $1 billion.

Social Media Stock Commandment #6:

When the company's brand is about to expire, they must acquire.

Social media companies can’t hope to rely on their incipient platform forever. This would be akin to expecting Western Union to have stayed in the telegraph business. But social media companies can thrive via acquisition of more innovative platforms. Be it Facebook buying Instagram or Yahoo Inc. (YHOO) buying Tumblr, acquisitions can do wonders for diversification and ensuring a company can stay relevant long after its primary business model has become outdated.

Without diversification, a social company is always one MySpace away from becoming Friendster, who of course were one Facebook away from becoming MySpace.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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