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EV/Revenue: Scary Heights Of Social Media Stocks

A lot of investors hoping to get rich on sales growth are looking to shares of social media companies like Yelp (YELP), Twitter (TWTR) and Facebook (FB), which trade up almost exclusively on delightful revenue gains. But today’s investors are paying even more for sales than their counterparts did back in the dotcom era, and far more than most buyers ever did for that famously successful growth stock, Amazon.com (AMZN). This should probably worry anyone who recently bought shares of Yelp or the like.

YELP Chart

YELP data by YCharts

Amazon’s success at building phenomenal investor returns through revenue growth alone has convinced many investors that they can overlook the share price valuations and still get great returns for many years. After all, Amazon shareholders are up nearly 440% in five years although investors bought them at PE ratios that were often some eight or nine times higher than most companies of its size.

AMZN Chart

AMZN data by YCharts

But by looking at the enterprise value to revenue ratios, we can see that those Amazon investors never paid the kinds of price for revenue that today’s investors in social media phenomena are coughing up. As the chart below shows, Amazon’s forward enterprise value to revenue ratio peaked at about 2.3 in the five-year period. By contrast, the forward enterprise value to revenue ratios for Yelp, Twitter and Facebook now range from about 15 to 24.

AMZN EV to Revenues (Forward) Chart

AMZN EV to Revenues (Forward) data by YCharts

It’s an ominous sign for recent investors in these social media shares. Goldman Sachs (GS) last week released research showing that only companies with truly exceptional growth reliably outperform the market when bought at exceptionally high enterprise value to revenue ratios. Goldman found that stocks trading at the top of the EV/revenue range generally lagged their peers on 1-, 3- and 5-year returns no matter how fast their sales grew. The cheaper ones performed better.

In other words, price does matter, even when buying shares solely for revenue growth. And prices now are exceptionally high. Not only is the overall market routinely hitting record highs now, the median enterprise value to sales ratio for Russell 3000 stocks now is higher than it’s been in 35 years, according to Goldman. The YCharts Stock Screener shows Twitter and Yelp among the top 10 most expensive stocks on the measure in the NYSE and NASDAQ, of companies with market caps over $5 billion. Facebook isn’t far behind.

It’s difficult, to say the least, for an investor to peg which expensive companies will have enough sustained, truly exceptional growth to justify their irrational prices. A more practical approach would be to filter a list of growth stocks for shares with more explicable valuations. We offer a start here to this exercise by setting the YCharts Stock Screener to show Internet stocks, each detailed with an annual revenue growth rate alongside the following forward ratios: enterprise value to revenue, EV/EBITDA and price to earnings. Clicking on the header of any column will sort the shares accordingly.

There are, of course, hundreds of other metrics that can be used to value a stock, even when revenue growth is its sexiest characteristic. Find your favorite on the Screener to add an information column or narrow the results. Or unleash financial advisor tools on an individual stock.

Dee Gill, a senior contributing editor at YCharts, is a former foreign correspondent for AP-Dow Jones News in London, where she covered the U.K. equities market and economic indicators. She has written for The New York Times, The Wall Street Journal, The Economist and Time magazine. She can be reached at editor@ycharts.com. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.

Read more articles about: Investing Ideas  stocks that look pricey   tech stocks   

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