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I Wouldn't Touch Truth Social Stock With a 10-Foot Pole. Here Are 3 Things Smart Investors Should Know.

Motley Fool - Wed Apr 3, 3:10AM CDT

The stock market has gotten off to a red-hot start this year with the S&P 500 and Nasdaq Composite hitting new highs in the first quarter. Unsurprisingly, businesses are looking to take advantage of the positive momentum and get in on the action.

Specifically, 2024 has featured some exciting initial public offerings (IPO). The social media landscape is particularly active with high-profile companies like Reddit recently going public.

There was also the long-awaited public debut of Trump Media & Technology Group(NASDAQ: DJT), also known as TMTG, home to app Truth Social.

Shares of TMTG have declined 16% from their Mar. 26 closing price, the first day they began trading under the DJT ticker. Is TMTG the next big market opportunity?

Let's dig into three things investors should be aware of before scooping up shares.

1. Beware of SPAC stocks

TMTG took an untraditional path to going public. The social media business merged with a special purpose acquisition company (SPAC) called Digital World Acquisition.

SPACs briefly became popular a few years ago, thanks in large part to Chamath Palihapitiya, a Silicon Valley entrepreneur known as "The SPAC King."

DeSPAC is the term used when a company merges with an SPAC and begins trading under its official ticker. Since its deSPAC event, TMTG stock has already experienced major volatility with shares rising 33% before giving up those gains, all in its first week of trading. The media company boasts a market capitalization of $5.8 billion as of this writing.

SPACs have largely fallen out of favor, and for good reason. According to the data tracking website SPAC Insider, the long-term median return for deSPAC stocks with market capitalizations over $5 billion is negative 73%. Moreover, SPAC stocks in the technology and media industry had an even worse median return of negative 82%.

2. The competition is intense

The social media landscape is highly competitive. While different platforms offer unique features, the overall thesis among social media applications largely remains the same: Build a large, engaged community that can attract advertisers.

Meta Platforms is the best example of this business model. The company owns Facebook, Instagram, and WhatsApp, and this family of apps has amassed 3.98 billion monthly active users (MAUs). Those users were key to the $132 billion of advertising revenue reported last year.

But for Truth Social, I see X (formerly Twitter) as its closest competitor. Owned by Elon Musk, the platform has 528 million MAUs. By contrast, Truth Social is estimated to have just 5 million active users.

The overarching theme here is that while the barriers to entry in social media are relatively low, achieving critical mass and enticing users to stay and engage on any given platform platform is the real challenge. Given Truth Social's small scale relative to the most influential players in social media, there is a lot uncertainty surrounding its future.

3. Unproven growth prospects

Truth Social has been around since 2022, and management hopes to expand the platform into other areas of media and entertainment.

For instance, management used subscription services such as Netflix and Spotify as comparable peers in its investor presentation as the company prepares to unveil a new streaming content service.

However, according to the original investor presentation published in Nov. 2021, management was also forecasting 41 million users by the end of 2023. With just 5 million estimated as of Feb. 2024, it's clear the platform's actual traction has fall far short of what was initially anticipated.

Buying shares at the company's current multibillion-dollar valuation carries too much risk that you'll be left holding the bag as the current hype dies down and the company's financial woes become increasingly apparent.

Truth Social's ability to evolve into a multifaceted platform disrupting several corners of the media landscape is unproven. With revenue of just $4.1 million and $58.2 million in losses last year -- much of that driven by hefty interest expenses -- it has its work cut out for it to grow into its nearly $6 billion valuation.

While investors are free to tune into earnings calls and monitor management's commentary, they should stay on the sidelines as there are too many unknowns to justify the company's lofty valuation. For anyone interested in social media stocks, there are much better options.

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Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Adam Spatacco has positions in Alphabet and Meta Platforms. The Motley Fool has positions in and recommends Alphabet, Meta Platforms, Netflix, and Spotify Technology. The Motley Fool has a disclosure policy.

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