As momentum play Twitter, Inc. (NASDAQ/TWTR) plummeted 24% to $50.00 last Thursday morning, my response was—it’s about time.
Here’s what I’m thinking: the superlative price spikes in social media Internet stocks in 2013 were truly obscene; in fact, I think the extreme buying was overdone.
The sell-off in Twitter last week actually gave me some confidence, thinking the stock market was finally getting back to some level of normalcy.
In the case of Twitter, the company managed to beat on its revenue estimate but provided soft user growth, which we all know is the backbone of social media Internet stocks. That’s why an Internet company like Facebook, Inc. (NASDAQ/FB), with its more than one billion subscribers, has so much potential. (Read “My Top Stock Pick in the Internet Space.”)
Twitter, even with the 23% haircut, is still so overvalued, trading at a whopping 440X its 2015 earnings per share (EPS) and a massive price/earnings-to-growth (PEG) ratio of 296! These are simply metrics that are obscenely out of line, even for the Internet space.
The irony was that it wasn’t until Twitter released its results that Wall Street then decided to downgrade the stock. Twitter was downgraded to a “Sell” by UBS. (Great hindsight analysis… Why not simply downgrade prior due to the extreme valuation?)
At the current $50.00 level, I would wait to even consider buying this stock, as the valuation is still out of line with the company’s fundamentals and outlook. A price at which I would seriously look at Twitter is below $30.00—if it ever reaches that point.
Now, while I do like the social media and Internet services spaces going forward, I’m just not that comfortable with the current lofty valuations.
Another high-flying Internet stock that looks vulnerable to downside weakness is Yelp, Inc. (NYSE/YELP), a provider of online help and ratings for goods and services. Like Twitter, with the stock trading at 134X its 2014 EPS and a PEG in excess of 10.2, you also have to wonder about the valuation and downside risk of Yelp. If you are thinking of playing the downside, I’d advise using put options instead of the much higher-risk short-selling strategy.
A social media Internet stock that I do like is LinkedIn Corporation (NYSE/LNKD), which allows people looking for business connections to network. The stock trades above $210.00 a share, so much of the easy money was already made in this stock over the last few years. Trading at 97X its 2014 EPS, the stock looks expensive, but based on its PEG of 2.46, the valuation isn’t all that bad. Nonetheless, I would only consider being a buyer of this Internet stock on market weakness or entering via selling put options to set a lower exercise price while generating some premium income from the puts.