What Social Media Stocks Can Tell You About the Market

With the recent initial public offerings (IPOs) of social media companies, I think we should take a look at the recent performance of these stocks, because they might be a canary in the coal mine signaling overall market sentiment. Since their IPOs, all of these “hot” social media stocks have performed poorly of late. Zynga Inc. (NASDAQ:ZNGA) was the latest social media firm in the batch of IPOs, offered at $10.00, and hitting $11.50 on its first day before trading at $9.00 currently.

Groupon, Inc. (NASDAQ:GRPN) is trading slightly above its $20.00 IPO price, but it has been as low as $14.85. LinkedIn Corporation (NYSE:LNKD) has had a huge rollercoaster ride; having its IPO at $45.00 and proceeding to hit a high of $122.00 before falling to a low $56.00.

Even though these IPOs might not deserve to trade at the crazy multiples that they do, they are a key indicator that money is pulling out of the markets. A contraction that is seen in the speculative sectors might eventually flow to the blue-chip names as well eventually.

I know what you’re thinking: “So what if Zynga and Groupon perform poorly? That won’t have an effect on my investments.” Each stock on its own, no, it won’t. But, as a key indicator, there are signs that scared money is being pulled out and investors are nervous about their entire investments, souring market sentiment. If you were to ask someone back in 2001 if they cared that Pets.com went bust. They probably didn’t, unless they owned those shares, but everyone suffered in the ensuing pullback in the markets. The collapse of the dot-com sector was an early key indicator for that time period; the leading edge that was that time period’s canary in the coal mine.

Looking at this current batch of IPOs, there are still several areas to worry about in addition to the macroeconomic issues we’re facing. Sixty percent of social media stocks that have had IPOs since 2010 are below their initial offering price. It appears that these companies and bankers are selling as much as they can now, because if more money is pulled out due to poor market sentiment, no one will be left to buy them. Not to mention the overhang of more shares coming onto the market as lock-up periods end for these IPOs. LinkedIn alone has 55 million shares unlocked and available for sale in February.

I’m not advocating that these companies deserve to trade at these high multiples. LinkedIn is trading at a forward price-to-earnings (P/E) ratio of approximately 200, depending on which earnings estimate you use. Many question how Zynga is worth more than an established computer gaming firm like EA Sports. Groupon is estimated to earn some positive earnings next year, perhaps a forward P/E of approximately 100. These are all companies I wouldn’t invest in since they’re more about the current “fad” and most investors are extremely short-term speculators.

So, yes, they are expensive based on many metrics. In no way do I recommend looking at this group as the biggest key indicator, but they certainly are a peek into overall market sentiment. It’s interesting to know what the speculators are doing on the margins, the leading edge of the markets. These riskier stocks will also indicate investor appetite for new ideas, which might affect stocks in different sectors that are young and developing.

Just as the dot-com bubble bursting hit all stocks and speculative real estate in various markets, like condos in Miami, hurt the entire nation’s real estate market, I would suggest looking at any potential shifts in market sentiment and investing to protect your assets from becoming collateral damage. Be careful of the riskier segment in the markets and stick with boring but stable stocks that will survive far into the future.

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