In a move away from tradition, Janet Yellen used her semi-annual Humphrey Hawkins testimony to the Senate Banking Committee last week to speak directly about specific sectors on the US market:
'Signs of risk-taking have increased in some asset classes. Equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched, with ratios of prices to forward earnings remaining high relative to historical norms.'
The speech led to flurry of activity from traders, sending the NASDAQ, Russell 2000, US Tech 100 and S&P 500 down for the day. It has also led to some debate; many commentators read Ms. Yellen's comments as only applying to smaller cap social media firms (which would discount Facebook, Twitter and LinkedIn).
The genesis of Ms. Yellen's speech is perhaps the much publicised trouble that social media firms often have when attempting to monetize their user base. Failing to turn users into revenue leads to low earnings, and in turn stretches P/E ratios as investors trade on the potential of companies to generate profit instead of actual figures.
Problems arise for a company if the market does not believe in that potential. Facebook spent its first few months on the market in free fall, dropping to less than 50% of its original value. It offered little to convince investors that it could turn a corner, until figures showing big increases in ad revenue - from mobile users in particular - caused a rally in its price.
Facebook's stock certainly has a high PE ratio, at 89.55 (compared to an average of 35.32 for its index). When it releases its second-quarter figures on Wednesday 23 July, however, most expect that ratio to drop, as year-on-year earnings per share are predicted to grow by 68%. If those high expectations are met Facebook will come closer to justifying the faith that the market clearly has in it.
It may well be that Ms. Yellen saw the market's reaction to Facebook's turnaround distil into other notable social media stock, as traders attempted to repeat those impressive gains. After a dismal start to the year, Twitter had a good run on the markets in June: rising from a share price below $33 to one above $40. Twitter has done a lot of work to increase its ad revenue, but as yet has not hit profit.
Analysts do not yet expect Twitter to be profitable, but it is driving towards profitability at a faster rate than many had predicted. However, user base growth has not been as strong as hoped in the past, and any speculation on Twitter to become a revenue generator is a gamble.
If Ms. Yellen was warning against such a risk, it appears to have been heeded. Twitter stock tumbled below $38 on the day of the speech, dropping 2.8% as the news hit traders.
It was Yelp, though, that appears to be amongst the worst affected. Yelp stock closed on Monday at $71.1, and proceeded to hit $67.2 in a 5.5% fall. Like Twitter, Yelp's market cap. had been on the rise in the run up to July but has hit rocky times since. Both companies will need a strong earnings report this summer to show investors that they can prove Ms. Yellen wrong.
There are many social media stocks on the markets that have a share price that is not in line with their earnings. Whether this new form of business requires different metrics to measure success, or is a collapse waiting to happen for investors, remains to be seen. But Ms. Yellen's calls for caution are probably a sensible step.
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