Social Media Stocks! Should you invest?

Facebook, Path, Pinterest, Groupon, Pandora! We use these social media tools everyday although no one seems sure if they are actually profitable. This year is the year for social media IPOs! Although there is a lot of press around Facebook’s IPO, social media companies that have recently become public have had disappointing results in the market. Social media is new territory for all investors, so I thought that this week I should discuss some questions to ask when you are thinking of investing in a social medial company.

How does the company get Revenue?

Social Media is great! It’s free! It connects people all around the world.  The question to ask when thinking of “buying in” is where is the revenue coming from? Is the company getting revenue from advertising? Subscriptions? Are they receiving revenue at all? If so, are they creating enough revenue to maintain the projected Price/Earning ratio? (If you would like more information on P/E, check out this link: http://www.investopedia.com/terms/p/price-earningsratio.asp#axzz1pCJkstD2).

In short, when considering investing in a social media company, take a look at their revenue and decide for yourself whether or not the growth is sustainable.

What is the Net Profit Margin?

The net profit margin is really important when looking at any company, but especially when considering young companies. The net profit margin is the ratio of how much money is used to run the business and make the sales. It shows how profitable the business will be during its growth phase and how efficiently the company is run. Let’s take a look at Groupon:

Although they have made $1.62 billion dollars, they are still spending more money than they make.  This is the reason why the stock has disappointed initial market expectations.  It worries potential investors that a service company, which doesn’t offer a concrete product, consistently loses more money then they make.

What are the markets expectations of the stock?

Facebook is a huge IPO and is expected to make a lot of shareholders billionaires! However, with such a high price comes high Wall Street expectations.* Facebook will have to quadruple in size over the next five years to justify the current price of the stock.  For a company as big as Facebook, this may not be so unreasonable, but it is important to keep market expectations in mind when looking at other social media companies.  Wall Street is also ruthless if they feel like a company is not growing according to their initial expectations. The stock could take a huge hit if anything goes wrong the first year Facebook is public.

Do you buy anything and if so how often?

When researching any stock, an important question is always “do I use this product?”. For social media sites, it is not only important if you use the product, but since social media primarily relies on advertising for revenues, it’s important to consider how often you purchase something from an advertisement on that particular social media. I tend to buy Groupon’s all the time. And although I get some ideas of things I want to purchase from my Facebook page, I have yet to click on an advertisement and, as a result, buy a product. So I am weary of Facebook’s advertising strategy.  Pandora is another good example of this! I listen to Pandora everyday; however, I have not bought any music from that app option, nor do I remember any commercials that were played between songs.

To summarize, enjoy your social media but remember that before you invest you should use the above questions to make sure core of business provides a quality product or service.

* This does not mean that I do not believe in facebook and if you are a young risk tolerant investor, facebook would be a fun stock to buy, hold, and most importantly sell.