History never repeats itself exactly, but it tells us enough that we can learn a lot from it. What we learn can help us avoid making mistakes that cost us oodles of money.
In investing, avoiding mistakes is more than half the battle.
We are all aware of the mistakes that many investors made 15 years ago. In the late nineties, a new generation of investors rushed to invest in the stock market because they had seen their friends making easy money with “dot.com” stocks.
These investors paid no attention to valuation and lost gobs of money when the dot.com bubble crashed.
With the benefit of hindsight these investors look foolish. At the time it wasn’t hard to see why these inexperienced investors were willing to leave caution to the wind and gobble up “dot.com” stocks irrespective of price. There had been valuation warnings for several years and yet these stocks had done nothing but go up anyway.
For quite some time it didn’t matter what price dot.com investors paid, the stocks always went up. But that is the funny thing about valuation and stock investing. Valuation doesn’t matter, until it matters.
The game is fun until the point when the music stops.
When that time comes where valuation does matter, stock prices of massively overvalued companies can fall faster and further than most people could imagine.
Today a similar thing is happening with social media stocks like Facebook (NASDAQ:FB) and Twitter (NYSE:TWTR) where a new generation of investors may be faced with learning a lesson that the “dot.com” generation will never forget.
Let me walk you through some numbers to give you an idea of how the stock market is currently valuing the Twitter business specifically.
With 570 million shares outstanding and a current stock price of $39, Twitter has an enterprise value of $22 billion.
That means that when you buy a share of Twitter today at $39 you are saying that you think $22 billion is an attractive price at which to own a share of the Twitter business.
Do you know how much money Twitter made in its last fiscal year for its shareholders?
Actually that isn’t true. According to Twitter’s last annual filing the company lost $645 million, which is a continuation of losses that were experienced in the year before that, and the year before that as well.
The stock market is valuing this money losing business as being worth $22 billion.
Don’t get me wrong. I love growth stocks and Twitter is definitely one of those. I realize that incurring losses can be part of the growth model which is designed to build a dominant product.
The chart below shows the rapid pace at which Twitter is gaining users. The company is doing good things.
At some point this company will turn the corner and become profitable, I don’t doubt that. What I doubt is that Twitter can become profitable enough to justify the current valuation.
And Twitter shareholders need better than that, for the stock price to increase business performance will have to more than justify the current valuation.
At some point the market is going to demand earnings and cash flow from this company.
At the moment there is no financial metric that supports Twitter’s current valuation. These shares could drop 50% simply based on one disappointing quarter.
Twitter (and Facebook too) are all risk and no reward at current share prices.
Buy The Picks And Shovels
Just like the internet wave of the late 90s, the thing about social media is that it is very real and is going to create some huge wealth. I’d like to be part of that, I just don’t think owning Facebook and Twitter at this point is going to do it.
Instead I’d prefer to look where other social media investors aren’t. I think a better route to take is to consider under the radar companies that offer much greater leverage to the continued growth in social media but not the crazy valuations of the big players.
IZEA Inc. (IZEA) is the “middleman” of social media. Like the companies that sold the picks and shovels to prospectors to profit from the gold boom, IZEA profits from the social media boom rather than being a form of social media itself.
IZEA has a simple business that anyone can understand.
IZEA creates marketplaces where an advertiser can find a celebrity or other influencer to promote their product. The celebrity of influencer will tweet, blog or use other forms of social media to promote the company’s product to the influencer’s followers.
The advertiser will obviously pay the influencer a fee for this, and IZEA takes a cut of that fee for acting as middleman.
What I like about IZEA is that it has already established a big advantage by building a huge “influencer” rolodex.
IZEA’s network covers more than 170 countries and over 850,000 influencers this is a critical mass that can’t easily be replicated.
There is great benefit to being an early entrant to a new and powerful trend. As a first mover, once your hooks are in, you become very hard to shake.
While social media has been in the mainstream conscious for quite some time, it really is still only in its early innings.
While 75% of advertisers now say they use paid social advertising, the percentage of their budgets directed to it are still growing every year. According the Nielsen 2013 paid social media advertising report 64% of advertisers were increasing their social media advertising budgets in 2013.
This reminds me of the early years of Amazon.com (AMZN) where it seemed obvious that internet shopping was going to be big, but pulling the trigger on early stage unproven companies was scary for many of us.
Revenue growth and margin expansion for IZEA over the past four years has been consistent and quite rapid.
At this early stage of the company’s life growing revenue and establishing a critical mass and building a moat is priority number one. But it is good to see that while doing this IZEA has been also able to reduce its costs.
The 850,000 person strong marketplace that IZEA has founded is the place that advertisers know to go to.
Establish the business first, then turn the screws on profitability.
What I think is apt to be the future for IZEA though is a buyout from a larger company.
It would be much easier for a Twitter or a Facebook to go ahead and acquire IZEA than it would be for them to spend the time to try and build something similar from scratch.
Buying an existing business rather than building it internally is commonplace in the social media sector (as can be seen from the list below).
I would imagine it is clear to most readers but I need to stress that exposing money to small companies in emerging industries is risky business.
As an investment IZEA offers interested parties a chance at multi-bagger type returns. For that kind of potential there is always an elevated level of risk.
Concerns that I have would include:
- The threat from exponentially larger competitors who could take IZEA’s business if they chose to spend the money to do so.
- As an emerging company there is always the chance of equity dilution and that dilution might not always happen at a happy price
- This will be a very volatile stock.
Today I think Facebook and Twitter, while great businesses, offer lots of risk and little chance of reward. I wouldn’t touch either with a ten foot pole because of their lofty valuations. IZEA also offers a lot of risk, but in exchange for that investors get exposure to the possibility of significant growth.
Investors don’t have to have exposure to social media at all, but if that is something you want I’d recommend looking to the “picks and shovels” companies like IZEA instead of the overvalued social media providers themselves.