Many growth investors have flocked to the social media sector. I haven't. Let me explain why.
It starts with lack of choice. For investors, there are really only two companies that matter in the sector right now: Facebook Inc., with a market capitalization of $51-billion (U.S.), and LinkedIn Corp., with a market value of $11-billion.
To be sure, there are other firms, such as Zynga Inc. and Groupon Inc., that have had their moments of glory and frequently get mentioned in roundups of social media stocks. But neither passes muster as an investment and neither is a social media company in the purest sense.
Zynga is really a gaming company that happens to take advantage of Facebook's social network. Its share price has been plunging and it's not going to come roaring back any time soon. The company's innate problem is that other people can also create great online games; Zynga has no particular monopoly on the area.
Groupon has an interesting e-commerce platform for group coupon deals, but while some people label it a social media stock, it is about as social as the bargain bin outside a bookstore. Lots of people flock to it, in search of an awesome deal. But they don't interact with one another or develop any special loyalty to Groupon – if they don't see something they like, they move on.
So that brings us back to Facebook vs. LinkedIn. The former has a billion monthly users; the latter, 187 million registered users.
Based on these numbers, Facebook is 5.4 times the size of LinkedIn, but, if anything, this ratio is understated. A LinkedIn "registered user" may not touch the site in a given month, while Facebook is at least reporting on active users.
A look at their revenue numbers shows a similar gap. Last quarter, LinkedIn pulled in $252-million; Facebook collected $1.26-billion.
Many people argue that LinkedIn's audience of business and professional people is innately more profitable than Facebook's broader user base. I'm not so sure. The gap on a per-user basis is not that big – $1.34 per user for LinkedIn and $1.25 per user for Facebook. And Facebook appears to be doing a better job of finding ways to monetize mobile traffic.
The one area where LinkedIn does definitely have an edge is growth. According to S&P Capital IQ, analysts expect LinkedIn to grow its revenue 50 per cent next year compared with 28 per cent for Facebook. This may reflect a belief that LinkedIn will catch up on monetizing mobile traffic.
Investors, though, should look beyond one-year growth rates and consider which company is more powerful and less risky. To my mind, Facebook wins the competition, hands down.
More power? Yes, because Facebook is far larger than LinkedIn and can build a more significant advertising platform.
Less risky? Yes, because the professional networks on LinkedIn could easily be threatened by Google Inc.'s social network, Google+, which has a much wider appeal among professionals than it does among non-professionals. Facebook could also decide to enter the job placement market, diminishing LinkedIn's value.
So would I buy Facebook shares today? Nope. Despite its superiority over LinkedIn, neither strikes me as particularly compelling at current prices. LinkedIn shares are changing hands at 11.6 times sales, Facebook shares are going for 10.2 times sales. Both are sky-high valuations that assume the companies will grow at double-digit rates for several years. If anything disrupts that growth, all bets are off.
If you absolutely must have exposure to social media right away, my recommendation is to look at Google, which I own personally and in my Strategy Lab model portfolio.
The company is by no means a pure social media play, but Google + has potential and Google's model over all is far superior to Facebook's – and far less risky.
An even better strategy might be to wait. Twitter isn't public today, but it will be one day. It has an incredible platform, an enthusiastic user base, and an ability to monetize its network. When it starts offering stock, my skepticism about social media may change.