STAYING FRIENDS

Why investors should be patient with social media stocks.

The recent weakness shown by some of social media’s biggest players may have investors hitting the unfriend button on the whole sector.

Shares in Twitter Inc., Yelp Inc. and LinkedIn Corp. have fallen 20 per cent or more since reporting disappointing results or guidance last week, which should serve as a reminder of just how volatile the space can get.

The pressures these companies face in areas such as advertising, in particular, warrant some caution from investors, particularly given the high expectations for their businesses.

But the numbers weren’t all bad, and none of them are going anywhere, so those with a long-term perspective should calm down.

In some cases, the expected numbers were just too optimistic.

For example, Twitter’s Q1 earnings were substantially below both guidance and analysts’ forecasts, but advertising revenues climbed 72 per cent on an annual basis.

Its ongoing investment in things such as helping large brands figure out how to use the platform as a marketing tool failed to translate into the growth many anticipated, and product development is generally not going the way the company said it would, nor is advertiser outreach.

Let’s face it, the platform is pretty much unproven as a widely used tool for advertisers, but it at least holds a niche position in the digital advertising marketplace and it will capture a growing share of this market. It has to.

That’s why the Twitter selloff can reasonably be considered an overreaction.

“Whether you grow 70 per cent or 100 per cent, it’s all pretty good — just less than some thought it would be,” said Brian Wieser, a New York-based Internet and advertising analyst at Pivotal Research Group, who upgraded the stock to buy from hold. “It doesn’t necessarily change long-term expectations, but most of the market is reacting to what it can see in front of itself — the results that just came out.”

If there is one commonality among social media names, it’s that expectations often get ahead of reality. A reset to more appropriate levels is welcome in that respect, since their stocks leave no room for speed bumps from a valuation standpoint.

LinkedIn, for example, grew year-over-year membership by 23 per cent, with all-important mobile visitors outpacing the total at 39 per cent. User engagement trends were also evident in the company’s rapid growth in page views.

However, LinkenIn cut its Q2 and 2015 guidance as a result of currency headwinds and margin reductions stemming from sales training and acquisitions. As a result, the stock is down about 20 per cent since Thursday.

It isn’t all that different at Yelp, where a change in the company’s sales structure hampered productivity in January. That should be an isolated problem.

The stock had also been rallying leading up to the results, making the magnitude of the pullback — 24 per cent — less surprising.

Yelp’s local ad revenue was up more than 50 per cent year over year, but that was down from 60 per cent in Q4, along with a dip in the number of local advertising accounts for the online business review platform.

Yet the number of reviews posted on Yelp reached a record six million in Q1, and 65 per cent of the searches came from mobile.

That positions the company well to take a bigger piece of local ad dollars — a market where it is still underpenetrated — leaving plenty of room for strong revenue growth and margin expansion.

“We think the pace of innovation in new advertising products is accelerating and the company is making good progress towards closing the loop for advertisers,” said J.P. Morgan Internet analyst Doug Anmuth.

Of course, Google Inc. and Facebook Inc. remain a big threat to further growth in users and advertising for Yelp and most other social-media players.

But it’s up to the companies to execute on their own solutions, which is why investors should pick individual stocks rather than an exchangetraded fund such as the Global X Social Media ETF.

The recent drop in socialmedia stocks opens the door to what looks like a good longterm entry point for some of the sector’s companies. Just make sure you follow the right ones and unfriend or block the others.