Considering Facebook’s outlook and recent trend, this ratio is highly attainable.
Understanding the cult
A “cult stock” is defined as having a sizable investor following despite somewhat insignificant fundamentals. In theory, these are speculative stocks, or those that are bought on potential. Immediately, companies such as LinkedIn Corp (NYSE:LNKD), Workday, Netflix, or Tesla might come to mind, but truth be told, the label is fitting for most social media companies .
Among those in social media, I think both Yelp Inc (NYSE:YELP) and Zillow Inc (NASDAQ:Z) fit the mold, along with LinkedIn Corp (NYSE:LNKD).
Yelp Inc (NYSE:YELP) has rallied 210% in 2013 alone. Almost a quarter of those gains followed Yelp Inc (NYSE:YELP)’s Q2 earnings report. In that quarter, revenue was just $55 million (69% gain over the prior year), and the company posted an EPS loss.
When you consider the company’s $3.8 billion market cap, it is hard to justify a 50% rally behind $55 million in quarterly sales. Yet, the company’s 20.4 times sales valuation appears almost meaningless to investors, and with 20% of its float being short, many believe there is still room to run even higher with short covering.
Zillow Inc (NASDAQ:Z) has rallied an even better 255% this year. The online real estate listing company had a decent quarter to start the year, but most of its gains have come without news and with optimism surrounding the housing market. The company has raised money several times including the issuance of 2.5 million shares back in August . Yet, this hasn’t slowed down the stock, nor has its rising short interest, as Zillow Inc (NASDAQ:Z) now trades at 23 times sales.
For the ultimate case of irrational exuberance, LinkedIn Corp (NYSE:LNKD) announced a $1.2 billion stock offering and priced it at $223 . The next day, LinkedIn’s stock rose 4% to nearly $250 due to whispers that the money could fund a high profile acquisition. These speculative gains show that seemingly nothing – not excessive valuation or dilution – can slow down these cult stocks.
In the case of Facebook, this conversation is relevant because it appears to be on the road toward becoming a cult stock, if not already. Prior to July, Facebook could barely cross $26. Now, it’s around $45, and has continuously trended higher since its quarterly report.
With most cult stocks having some catalyst that creates optimism, whether it be an acquisition, earnings, or guidance, a simple spark is all that’s needed to create a multi-month (or year) rally.
Final Thoughts
In the case of social media cult stocks such as LinkedIn, Yelp Inc (NYSE:YELP), and Zillow Inc (NASDAQ:Z), 20 times sales looks to be the norm, which leaves a lot of room for Facebook to trend higher.
With that said, it’s hard to justify such a valuation as a good buy, as companies rarely maintain such a valuation for many years at a time. Yet, because of Facebook’s outlook, it’s likely to trade higher. Because although buying a stock at 16-20 times sales may contradict every rule you have about investing, in this particular space, this valuation is the standard. And clearly, Facebook is well on its way to meeting this standard.
The article Can This Social Media High-Flyer Continue to Trade Higher? originally appeared on Fool.com is written by Brian Nichols.
Brian Nichols is long Facebook. The Motley Fool recommends Facebook, LinkedIn, and Zillow. The Motley Fool owns shares of Facebook, LinkedIn, and Zillow.
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