Which Internet Stock Is the Most Overvalued?


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An eternal optimist, Liu-Yue built two social enterprises to help make the world a better place. Liu-Yue co-founded Oxstones Investment Club a searchable content platform and business tools for knowledge sharing and financial education. Oxstones.com also provides investors with direct access to U.S. commercial real estate opportunities and other alternative investments. In addition, Liu-Yue also co-founded Cute Brands a cause-oriented character brand management and brand licensing company that creates social awareness on global issues and societal challenges through character creations. Prior to his entrepreneurial endeavors, Liu-Yue worked as an Executive Associate at M&T Bank in the Structured Real Estate Finance Group where he worked with senior management on multiple bank-wide risk management projects. He also had a dual role as a commercial banker advising UHNWIs and family offices on investments, credit, and banking needs while focused on residential CRE, infrastructure development, and affordable housing projects. Prior to M&T, he held a number of positions in Latin American equities and bonds investment groups at SBC Warburg Dillon Read (Swiss Bank), OFFITBANK (the wealth management division of Wachovia Bank), and in small cap equities at Steinberg Priest Capital Management (family office). Liu-Yue has an MBA specializing in investment management and strategy from Georgetown University and a Bachelor of Science in Finance and Marketing from Stern School of Business at NYU. He also completed graduate studies in international management at the University of Oxford, Trinity College.

By John Cassidy, NewYorker,

This was the week that some Internet stocks hit an air pocket. Twitter, LinkedIn, and Pandora all fell sharply after issuing earnings reports that disappointed Wall Street. Relative to the rest of the market, though, online companies are still valued highly, and their prices have risen significantly. On February 6, 2009, the Nasdaq Internet index, which consists of eighty online companies, closed at 83.80. On Friday, five years later, it closed at 400.34. That’s a rise of more than four hundred and seventy-five per cent.

Which raises a question: After this week’s fall, which Internet company is the most overvalued?

Now, when I use the phrase “overvalued,” I’m obviously being old-fashioned. These days, we all know that tech stocks, particularly Internet stocks, aren’t subject to the financial laws of gravity that determine the values of fuddy-duddy corporations like General Electric, Time Warner, and Ford. They are, in fact, invaluable options on the limitless future of online commerce, which, one day soon, will pay off in limitless profits—and if you don’t get in now, you are a sucker.

Far be it for me, the backwoodsman author of a skeptical book about the dotcom bubble of the late nineteen-nineties, to suggest that there is any parallel between then and now. Clearly, such a suggestion would be fanciful, inaccurate, and irresponsible. But, just for the heck of it, let’s consider some valuation metrics that old-school stock-market investors—the Benjamin Grahams and Warren Buffets of the world—like to look at. To keep things manageable, I’ll restrict the analysis to twenty well-known Internet companies and four widely used ratios: price-to-earnings, price-to-book value, price-to-earnings divided by the prospective growth rate of earnings, and enterprise value-to-cash flow.

The accompanying chart shows the figures. I took them from the database of Yahoo Finance—an invaluable (and free) repository of information provided by one of Mary Meeker’s original Internet blue chips. The numbers were updated after the market closed on Friday.


First, let’s look at the price-to-earnings ratio (P/E), which is simply a company’s stock-market valuation divided by its profits over the past twelve months. The very fact that most Internet companies make a profit these days shows there’s been progress since the nineteen-nineties, but some of them don’t. On my list, six firms lost money over the last four quarters for which they have reported earnings: Groupon, Monster Worldwide, Orbitz, Pandora, Twitter, and Zynga. Of these, the biggest loss maker by far was Twitter, which lost $511 million in the fourth quarter of 2013 and $645 million over 2013 as a whole. The next biggest loser was the gaming company Zynga, which lost $48.6 million in the fourth quarter and $209.5 million over all of 2013.

Of the companies that generate profits, LinkedIn and Amazon are the two most highly valued. Their P/E multiples are 941 and 612, respectively. Netflix also trades at an impressive multiple (132) and so does Facebook (105). The firms with the lowest P/E ratios are Overstock, eBay, and IAC. Overstock, a retailer, trades at just five times its earnings, making it a value stock. (I should point out that companies like Twitter and Amazon don’t like people to focus on their net profits, which, they say, give a misleading picture of how their businesses are doing. That may be true. But value investors, such as Graham and Buffett, always keep a keen eye on the bottom line.)

Now let’s look at the price-to-book value ratio (P/B), which shows how the market values companies relative to the accounting value of the assets they own, such as computer equipment and real estate. (That’s the “book value” of the company.) By this metric, the most expensive stocks are Twitter, which trades at about 33 times its book value, Orbitz (23 times), Netflix (18 times), and Amazon (17 times). Looked at in this way, the bargain stocks are Monster (0.9 times book value) and AOL (1.7 times). By Internet standards, of course, both of these companies are granddaddies. (AOL went public in 1992, while Monster’s precursor company went public in 1994.)

The third valuation metric, the PEG ratio, is an interesting one. It takes the forward-looking P/E ratio—the earnings Wall Street expects a company to make over the next twelve months divided by its market capitalization—and divides this figure by the expected growth rate of earnings over the next few years. If a company is expanding its profits rapidly, a high P/E ratio may be justified. But if the P/E ratio remains high even after dividing it by the expected growth rate, that could be an indication of trouble ahead.

According to this metric, the most overvalued stocks are Overstock and Twitter. Thomson Reuters, which supplies this data to Yahoo Finance, reports that the earnings of Overstock are expected to fall over the next few years, so its PEG ratio is negative. Twitter, before it reported its results on Wednesday, had a PEG close to three hundred—a stupendously high figure. By Friday, Yahoo Finance wasn’t supplying a PEG ratio for the company; evidently, its earnings future is too hard to figure out.

The final valuation measure—some analysts would say it’s the most important one—is the ratio of enterprise value to cash flow, or E.V./EBITDA. The numerator is the total value of the company, including its stock and bonds. The denominator is the amount of cash the company generates each year before deducting for things like interest, depreciation, and taxation. Many young companies make heavy investments, which means they are forced to take large depreciation charges that depress their earnings. Looking at the cash flow they generate might provide a more accurate picture of their future prospects.

Another word of caution here, though. Capital IQ, the consultancy that provides cash-flow figures to Yahoo Finance, calculates them in a different way than the Internet companies themselves. Rather than reporting normal EBITDA figures, many of them release “adusted EBITDA” numbers, which exclude the costs of stock-based compensation. For companies like Twitter, which issues a lot of stock grants and stock options, the difference between the two can be considerable. It’s easy to see why the firms do this: the adjustments makes them look a lot better. According to its own figures, Twitter generated seventy-five million dollars in “adjusted EBITDA” during 2013. But, since this is an exercise in old-fashioned valuation, I’m going to stick with Yahoo Finance’s numbers.

According to these figures, the most overvalued companies, from a cash-flow perspective, are Twitter and Pandora. They both generate negative EBITDA, so their cash-flow ratios, if they were reported, would be negative. The other eighteen firms generate positive EBITDA. The one with the highest cash-flow multiple is LinkedIn, and the figure is 139.5. Netflix and Groupon come next, with E.V./EBITDA ratios of approximately 85 and 47, respectively. Once again, Amazon, with a cash-flow ratio of 43, is close to the top of the list. By this measure, the most reasonably valued stocks are AOL, IAC/InterActive, and Monster, each of which trade at cash-flow multiples in the single figures. In this sense, they resemble many non-Internet companies, which trade at similar valuations. (Pfizer, for example, has an E.V./EBITDA ratio of about nine.)

So which Internet company is the most overvalued? In all four categories, Twitter, despite losing almost a quarter of its value this week, is at or tied for the top. Pandora, which has no earnings and negative cash flow, isn’t far behind, but it has a lower price-to-book ratio than Twitter. Groupon and Zynga, two other chronic loss makers, are also near the top in several categories.

Among the firms that make a profit, Amazon and LinkedIn are the most highly valued: both of them score highly on all four valuation measures. Amazon, in particular, stands out. For such a large and well-established company to trade at more than six hundred times its earnings, seventeen times its book value, and forty-three times its cash flow is virtually unheard of. Even after the firm’s recent earnings disappointment, Wall Street clearly has a lot of faith in Jeff Bezos.

But the most overvalued Internet company of all, according to old-fashioned valuation metrics, is Twitter. It loses a bundle of money, it generates negative cash flow (after deducting the costs of stock-based compensation), and it’s still very highly valued relative to its assets and its growth rate. Even after its big fall this week, the stock is still trading at more than twice the price at which it went public last November: the I.P.O. figure was twenty-six dollars; on Friday, the stock closed at $54.35.

Now, it’s quite possible that the micro-blogging company will confound the skeptics, just as Facebook eventually did after losing roughly half of its value shortly after its I.P.O. Twitter is investing heavily, and hiring a lot of people, which helps explain why it isn’t making any profits despite rising revenues. As a regular tweeter myself, I can attest that the site delivers value to its users, and that it’s fun. The company’s C.E.O., Dick Costolo, while announcing the disappointing results, promised to take steps to boost the growth rate of Twitter’s user base, which fell sharply in the most recent quarter. Maybe he’ll succeed. For now, though, and from a traditional standpoint, the numbers say that Twitter takes the prize as the queen of overvalued Internet companies.

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