Are the Social Networking Companies Approaching a Peak?

The frenzy over LinkedIn's IPO a couple of days ago, in which its stock more than doubled in price during its first day of trading, is reminiscient of the tech stock mania of the late 1990s. In those halcyon times, companies with no profits, scant revenue and highly optimistic business plans were going public with enthusiastically received IPOs. The stock market was pushed up to levels that it hasn't, on an inflation adjusted basis, since regained. Of course, we all know the tech stock craze went the way of leisure suits, although the financial consequences from stocks were much more painful.

Leisure suits have made a comeback of sorts in the past year or so. And so have tech stocks. The craze du jour is social networking, which proponents claim to be the grand future architecture of the Internet. Maybe. Something similar was said two decades ago about Microsoft, whose MS-DOS operating system was virtually ubiquitous among personal computers. But Gates & Co. didn't get the Internet, which was then struggling to organize itself around a concept called the World Wide Web. Then, a decade ago, portals were seen as the behemoths of the 21st Century. Today, only Yahoo is left as a major albeit struggling portal. A half dozen years ago, Google was expected to be heir to the Internet throne. Today, it is a growing and prosperous company whose vision thing is flagging. Google once was going to become the library to humanity. Legal squabbling over copyright ownership of large numbers of books has bogged down that initiative. Google is a leader in cloud computing, but Amazon will offer formidable competition. Goggle had to play catch up in the browser battles against a nonprofit that puts out Firefox. Google's failed attempt last year to buy Groupon was a signal that its ascendency to the throne of the Internet is no longer seen as inevitable. If Google is a sure fire winner, why wouldn't the Groupon folks want to associate themselves with Google?

But no matter that previous innovators have matured and shrunken to mere mortal companies. Social networking is hot, and investors pant for shares. Logical analysis fell by the wayside with LinkedIn. It had $15.4 million of earnings last year yet has a current market cap of around $8.8 billion. Its 95 million shares outstanding are worth $93 or so each at current market prices. Earnings per share are about $0.16, resulting in a price-earnings ratio of 581 to 1. Considering that the p/e ratio for the S&P 500 index based on trailing earnings is around 17, it's fair to say that investors are, at a minimum, extremely optimistic about LinkedIn.

Facebook, the big prize among anticipated IPOs, has dallied in the not very private private placement market, where transactions reportedly imply a valuation of as much as $70 billion. While the absence of solid public information makes Facebook's valuations somewhat amorphous, it's clear that public investors are getting whipped into a frenzy by all the press coverage of Facebook's private offerings. Facebook has indicated it might go public in the next year or so. When it does, that's likely to be a major signal of a peak in social networking stocks. A lot of really savvy Wall Street insiders huddle around the corporate insiders at Facebook. Those folks surely won't sell until they believe they can maximize the price they get, which by definition minimizes the bargain public investors will get. It's possible for public investors to make money from an IPO (Google is one example). But the IPO is a moment when the odds may well be stacked against the little guy. Invest carefully.