Special Report-
I remember it like it was yesterday, September, 1998 just after my birthday and the dot-com bubble was in full inflation mode. Stocks were going public left and right. Many of them had never made a penny of profit and yet drew millions from investors. Bubbles were nothing new to the markets, but when we are in one, many seem to forget the past. Boy did they miss this one!
Late that month, a relatively new online auction company called eBay was coming to market and investors foaming at the mouth to get a piece of it.
During the height of the new “internet era”, where anything ending with “.com” was getting bought up by every sucker and supposed professional alike. Even with the meteoric rise of so many worthless companies, caution was thrown to the wind and traders continued to buy worthless companies right up into the new millennium.
I remember the first day of trading for eBay. The stock rose by nearly 300 percent and its market cap on that day was close to 2 billion, almost 6 times what its closest competitor Onsale.com was worth. It was an unbelievable showing and that was only the beginning for the fledgling online retailer.
For the record, I was a believer in eBay’s business. I thought their idea and website was pure genius, but I was extremely skeptical of the insane valuations that the market was willing to give them, so I didn’t buy in.
Starting with their debut on the NASDAQ, eBay proceeded to go straight up until about May of 1999, at which point they had a price to earnings ratio (P/E) of over 1000! In the months that followed, even with a drop in stock price, the price to earnings ration or P/E (which is a common way to measure a stock’s value) had risen to over 1600 at one point, before dropping back to a more realistic level as the company began to make real money.
The average P/E range of stocks in the S&P 500 index is somewhere between 14 and 18. So a reading of 1600 is rather insane, but sometimes justified if the company is expected to growth earnings at an exponential rate.
EPS, P/E and Price chart of eBay since its IPO
I bring up eBay, because they are not only survivors, but a success story among many of the very sad endings to dot-com era stories. eBay has continued to thrive and remains one of the top online retailers in the world today.
Unfortunately, this was not the case for most of the companies that came to market in the late 90’s and used the dot-com craze to get Wall Street to give them money. According to CNET, about 800 internet companies failed in 2000 and 2001, many more in the years to follow.
Try to recall how many dot-com boom companies are still in existence (and thriving) today…
You can’t use Google, Microsoft, Apple, Qualcomm, Baidu, Cisco, Intel or even America Online, as none of them were dot-com boom companies. America Online actually went public in 1992!
I believe that most of you would be hard pressed to recall more than a handful of dot-com boomers that are thriving in today’s market and yet today we are entering into another bubble, one that I call dot-com 2.0! There are companies coming to market right now that are barely making a penny in profits and yet commanding huge demand and prices from investors.
Whenever you have a major social, financial, technological or resource driven catalyst that creates a craze or causes crowds to panic, you have the making of a bubble. Bubbles have been caused by everything from ultra-low interest rates to the internet and even by tulip bulbs (Google that one if you are not familiar).
The recent craze is the rise of a new kind of human interaction. One that we’ve never seen or perhaps imagined.
After the craze dies down, there will be a handful of companies that not only make it through, but will thrive for years to come. It is our job to narrow the playing field and find the true diamonds amidst the masses of worthless zirconium out here.
Social Media, Dot-com 2.0
I guess I am most afraid now because even professional traders and money managers remember the flops and yet they are at it again. Perhaps because the premise is exciting in a time when the word really has nothing to be excited about .
It’s seems that this new sector has been drenched in love potion number 9 and no one is immune to the effects. This time the obsession is with everything surrounding “social media.” Social media being a broad reference to any business that is able to profit from the way we interact and market with one another as consumers and friends on the internet.
Social media’s guiding precepts are trust and viral networking. This is based off the idea that you will generally trust your inner circle of friends, family and acquaintances more so than some strange company that is marketing to you.
Social media also merges our day to day tasks and tools with subtle advertisements that “nudge” us to buy products when we are motivated. Social media websites like Facebook, Zynga and LinkedIn know what you do for a living, where you went to school, how old you are, the foods and cars you like and even what you like to do for fun, so they can customize ads and offer suggestions and ideas that you are extremely likely to respond to. This knowledge is extremely lucrative to a company that is trying to sell you something.
The truth is that no one has truly figured out just how big the social media revolution will be and therefore just about every company that labels themselves a “social media company” is commanding outlandish valuations in the stock market, but many are just pigs with serious lipstick on.
You’ll see below that the social media revolution can be extremely powerful (and intrusive). If exploited in the right way, companies can make millions from the information they gather. The question is both who will be able to do it right and how long will we let them?
Social Media Principles and Strategies:
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You trust your “friends”, so they become the experts recommending goods and services as opposed to a company telling you what you need. The social media site links you and your “friends” together allowing you to share your experiences.
(ex. Yelp, Facebook, Angie’s list, LinkedIn, Groupon, Google)
How it works:
It used to be that a company would advertise their goods and/or services through traditional outlets like print, TV and radio and the consumer would buy based on their ads.
As the internet brings manufacturers and consumers from all around the world closer together with many more products and services, it becomes harder to decide which company you want to do business with and to find the best deals. Social media gives you access to a circle of “friends” that you can ask for information immediately or see what products and services they are buying and why.
You can also see reviews of products and services from people around the world in your same demographic, which may help you decide if you’re making the right decision.
I believe that this aspect of social media is helpful, but only to an extent. Shills and emotional, unchecked opinions can skew results.
There will be a couple companies that are able to distill opinions and experiences into a useful medium.
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Social media websites, games and applications (apps) gain intimate knowledge about you and your behavior. That information is then used to sell you specific goods and services or to improve your user experience on the net or in other environments.
(ex. Facebook, Zynga, Groupon, LinkedIn, Myspace, Friendster)
How it works:
Imagine that you just got done watching the movie “bullet” on your iPad. (If you haven’t seen it, Steve McQueen races his 1968 Mustang through the streets of San Francisco and is renowned as one of the best chase scenes ever).
Well, Apple knows that you have watched the movie and how many times you watched it. If you are on Facebook, they know how old you are, about how much money you make and might even know if you are looking to buy a car because last week you posted on your page that your car had been stolen. Maybe over the course of the past year you happened to click “like” on the Ford Mustang. Chances are Ford and Facebook would be showing you ads for a great deal on the new Ford Mustang. You might just even buy it…
I believe that this is the most powerful aspect of social media and the one that will bring the most spoils to the company(s) that can perfect it.
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You the consumer exploit the social media site to gain exposure or gather “friends” with similar interests so that you can in turn sell them goods and services or build your brand.
(ex. Twitter, Facebook, Friendster, YouTube, Google+)
How it works:
You are a financial advisor selling your services online. You open a twitter account and being posting random information on the stock market on a daily basis. Over time, you build a following of “friends” that enjoy your commentary. Without spending a dime, you now have a captive audience of which to market your services.
Movie stars and other famous people actually get paid as a shill to tweet! Kim Kardasian was making up to $10,000 per tweet that she sent out! The sad part is that her list of followers grows every day.
This side of social media is more beneficial to the consumer or company selling the goods, not necessarily to the social media company. Twitter is the most popular of these type of companies, but I still can’t quite figure out how twitter is going to make big money unless they start charging per tweet J
I can see Twitter using algorithms similar to Facebook to track exactly what you are thinking at any given moment based on your tweets and selling that information to others. For now, I think Facebook still has the best of all worlds.
* The word “friend” is in parenthesis because social media outlets like Twitter, Facebook and others have purposely blurred the true definition of a friend to include just about anyone who is remotely connected to another. By doing this, they offer both parties a sense of trust and camaraderie that allows better bonding even if you never even met any of your “friends” or “followers.” This translates to a broader network for individuals and allows them to reach even deeper into your life.
-We are slowly become a society of what I call “friend gathers” where young people are judged by the size and scope of their “networks” even if they have no real relationships with these people. Having never interacted with many of their friends in person, communication styles are evolving. The rise of “Texting ” versus talking is a perfect example of this. Of course, for friends in far off lands before the age of the telephone, the only means to communicate was through the mail. But why would anyone want to go backwards?
Anecdotally, I have noticed that young people seem to be more disconnected to others on a real, personal level. This lack of intimacy and verbal communication could be an extreme detriment to the future of cultures around the world.
Finding Value in your Personal Data
Aside from the change in our communication habits, we have only seen the tip of the iceberg when it comes to exploitation and monetization of your personal data. Since people don’t seem to just talk anymore, there is a plethora of information that is sent via smartphones, computers and other web based devices. Just about everything you do online, on your mobile phone and in the cloud is tracked to some extent allowing companies like Facebook, Apple, Google and others to know more about you than your spouse in many cases, I’m dead serious.
As scary as that sounds, think about the value that information and the precision marketing that can come from it. Better yet, think about you knowing exactly what your customers are thinking and wanting at that very second and being able to offer them a solution when they need it most…
To put it in a different context, think back to when you were dating (or even in your married life). Ever wonder what the love of your life was thinking? What if at every second you knew exactly what was going through their mind? What if they wrote a detailed diary of every last thought and action in their lives and offered you a copy? Do you think that would give you an unfair advantage? Would you be able to exploit that information? Would you feel right reading that diary?
I wouldn’t want to, but that’s just me.
Companies like Facebook can read and distill every message, post, picture, search result and more using their algorithms and have your very personal diary at their disposal and not only will they use it, but they will make billions of dollars from the information contained within it!
Certainly there are privacy and trust issues surrounding all this, but the reality is that greed, popularity, interaction with others and the human desire to be heard, loved and even to eavesdrop all force us into playing the social media game.
Twitter alone allows just about anyone to gain popularity and a stage in front of millions without ever leaving your desk or doing anything significant, ask Paris Hilton who has millions of followers.
A Plethora of Players
Unless you have been living under a rock, you probably know that Facebook is the 800 pound gorilla in the room. Its website and services encompass just about every facet of what we call social media and they are the most widely used platform giving them the most information and control next to Google in my opinion.
Google can also be thought of as a quazi-Facebook and believe it or not, might be the sleeper sensation of the sector next to Facebook.
Many of the other companies in the space are just hangers-on, using the Facebooks of the world to gain advantage. Worse yet, there are companies that have services that can be easily re-produced or that are not even really viable to begin with (think Groupon or Shutterfly). At best many “social media” companies such as LinkedIn should be trading at values closer to their real peers like Monster Wordwide (MWW : NYSE)
Social media companies like Zynga find out about you and your behavior through online games where they study your habits, friends and interactions. Not only does Zynga sell you “stuff” directly, but they use your game playing time to weave in deals and suggestions for you to buy products from all different kinds of companies.
Some companies use all sorts of sneaky tactics to get inside your life. Even Alec Baldwin’s plane incident was a shill and turned into an international stage for Zynga’s game “words with friends.”
At this point, it’s becoming clearer which companies are actually viable and have staying power and which are destined to fail, although anything can happen.
Zynga was the largest Internet IPO since Google and coincidentally looks the best financially so far. Yet on its first day of trading, the stock actually moved 10% lower from its $10.00 IPO price. Perhaps investors are already getting wise to the game and seeing the cracks in social media wall.
I saw these cracks early with LinkedIn, just after its IPO. It’s stock was trading around $100 back in June of 2011 as seen in the chart above. Observing the hidden flaws in the company and in its astronomical valuation, I suggested that we buy puts on the stock immediately. Over the course of the next couple months, the stock dropped over 40% down to a low below $60. We took some nice profits in the stock and by the way, the selling is not over in LNKD.
LNKD Daily Chart
While I don’t think this company will fail, they have no business commanding such a high price to earnings multiple. Even at $70, they are grossly overpriced. In early December I decided to short the stock again when it bounced to $77 and sure enough, it continues to fall.
Who Will Win?
Myspace, Friendster and many others have flopped, even when some of them seemed destined for greatness. This is proof that the game can and will change quickly.
From my perspective, Facebook is the real true social media giant, who has woven its tentacles into not only our lives, but into the veins of traditional media. Just about every commercial I watch, the advertiser wants me to “like” their product (you can click like on Facebook).
Since they have just about everyone in their pocket and because their users are motivated by inherent, natural human tendencies, I believe they will thrive for a long time. Twitter will most likely be bought by them or someone else, which would be my only impetus to buy them when they begin trading publicly.
For most of the other publicly traded public companies, I think their stock would be better used as wall paper than assets in my account. As more and more of these companies come to market, my service Option Strategies Weekly as more and more opportunities to take advantage of! I will bring you the trades as they arise!
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