The share price of social media companies – LinkedIn, Twitter, and Yelp, to name a few – have gone on some bumpy rides lately. When LinkedIn told investors the year ahead wasn’t looking as rosy as previously thought, its stock dropped 20 percent in a morning. Twitter saw a similar plunge when it surprised the markets with weak earnings.
If social media stocks seem a bit volatile, “our belief is they should be,” says Rick Summer, an equity strategist at Morningstar.
That’s not because they’re social media companies; it’s that they’re growing fast and their business models are still uncertain.
“Many of these companies are forming new advertising products,” says Summer. “We don’t have a great deal of history in understanding how you and I as users will interact with those advertising products and how advertisers will value that degree of advertising.”
Therefore, the stock price of many social media companies isn’t based on how much they make today, but what investors believe they one day will, says Shyam Patil, a senior vice president with Wedbush Securities.
If suddenly a company’s not growing as fast as expected, investors will reevaluate.
“It’s kind of like compounding, right?” says Patil. “If you’re trying to figure out what $1,000 today is going to be worth in 30 years, a two percentage change in the growth rate is going to have a significant impact.”
That’s not unique to social media companies, nor does it mean they’re falling out of favor.
“When you look at the value of these stocks, they’re significant before and significant after,” says Brian Wieser, an analyst with Pivotal Research. “We can argue about whether the market overreacts – absolutely.”
Wieser says a volatile stock price doesn’t change the inherent value of these companies – just want Wall Street thinks that value is.
His reaction to Twitter’s recent drop? “Cheap now, time to buy.”
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