Here We Go Again – Tech Bubble 2: Social Media

It would seem that the only thing you need if you want to invest in the stock market these days is a terminal case of amnesia. Luckily for Wall Street, there seems to be a pandemic of it sweeping through the investor class in 2014. The fact that interest rates have effectively been negative for the last six years isn’t helping either. The result is predictable enough. It can be expressed in a simple calculation.

Free money + stock market = bubble

What’s truly astounding about this new episode, however, is that no one seems to care. Far from being repentant about its attempt to assassinate the world economy in the lead up to 2008, the banking cartel seems more defiant than ever in its determination to resurrect a house of cards on Wall Street. Nowhere is this more evident than in the frenzy of mutual self-delusion surrounding social online media.

The idea that Facebook, effectively an elaborate internet messaging service, is today valued at just under 175 billion dollars is a fiction so blatantly removed form reality that it’s hard to know whether to laugh, cry, or just jump off a bridge and be done with it. To put this into perspective, McDonald’s, one of the most iconic brands in the world, not to mention an actual business, is worth less than 100 billion dollars. Other “lagers behind” include Disney at 136 billion, Amazon at 114, At&T at 185, and Toyota at 149.

And Facebook is by no means alone. Twitter is apparently worth 25 billion dollars, while poorer cousins Linked In and Pinterest are worth 1o and 8 billion respectively. And if you missed the boat on these “bargains” you can always put your money into Candy Crush, whose maker, King Games, recently entered the market with a valuation of 7 billion. Failing that, there’s the online takeaway ordering service Just Eat, which, if you recently won the lottery at the expense of your mind, is said to be worth 1.5 billion dollars.

True, if you had thrown a big chunk of your hard earned cash at Amazon, Google or eBay when they first appeared you might now be reading this on your luxury yacht in the Seychelles. But there is a fundamental difference in the historic potential of these companies and the current crop of online hopefuls. They may all be based on the internet, but that is where the similarities end. Amazon and eBay sell things. Not through annoying and largely ignored banner adds, but as an actual vendor or broker of tangible goods. Google, in turn, is a vendor (Nexus phones), a software developer (Android), and an advertising giant through its innovative and hugely successful AdWords and AdSense platforms. These companies sell products and services directly to consumers and have huge and growing market share. In contrast, social media providers, while they may be growing, rely almost entirely on advertising. Much of it, ironically, for Amazon and eBay.

As with tech bubble one, the thing that seems to get both brokers and investors so excited is the numbers. Not dollars and cents necessarily, but people. Facebook has 1.3 billion active users. Twitter has just under half of that, while Amazon has only about 30 million regular customers. Yet at the end of 2013 Amazon made a profit of $0.66 from everyone one of these on average, while Facebook walked away with just $0.04 per head. Or to put it differently, Amazon made a profit of 20 billion dollars while Facebook made only 6. To understand just how absurd this situation is, if every man, woman and child on the planet was a Facebook user, and it managed to innovate a way to double its earnings per user, it would still be a less profitable enterprise than Amazon. Incidentally, such a rise would, at least in theory, make the company worth over a trillion dollars on paper in accordance with current thinking.

The problem is in the multiples. It was once generally held, and rightly so, that a company’s price-to-earnings ratio should realistically be around 10-1. Which is to say, a company should not really be valued at over ten times its annual earnings. Apple, for example, has a current PE ratio of 13.12. AT&T has a PE ration of 14.14. Kraft Foods, in contrast, is sitting a little high at 21.45. But these are all sober valuations when we look at Facebook, whose current PE ration is 98.15. This is what you might call nosebleed territory, or 10% optimism and 90% pure speculative madness.

If share price is a reflection of investor confidence in the potential of a company to grow, it’s difficult to see just where all this growth in the social media sector is going to come from. Perhaps analysts are factoring in the possibility that space travel will open up markets on other planets, or that the world itself will end before investors regain their wits and begin looking around for the exit signs. Who knows.

The simple fact is that like all bubbles, this one will burst eventually. When it does, you can count on two things: a lot of innocent bystanders will be standing inside the blast radius, and few of them will have seen it coming. The ones who did will have cashed out by then and used the proceeds to bet on the inevitable crash.

Alas, such is life in the “grow or die” economy, which has been on a collision course with the real world for the best part of a century now. It stands to argue that when real growth becomes elusive, an institution addicted to multiplication must necessarily turn to fantasy and empty hope to fulfill its needs. That regulators and politicians alike are willing to stand back and let delusion win the day is a testament to just how much we have come to rely on wishful thinking as an alternative to actual problem solving and the painful choices such a path would entail.