A strategy for playing the crazy world of social media stocks!

The tension in the stock market is clearly evident, especially with the NASDAQ and Russell 2000 breaching their respective 50-day moving average (MA). 

What we have seen in the stock market is a shift away from higher-beta growth and small-cap stocks to the perceived safety of blue chips and large-cap stocks, which I recently wrote about. 

Driving much of the current malaise in the stock market has been the selling in the technology groups, specifically the high-momentum stocks that attracted major buying euphoria in 2013, in spite of what were high valuations and overdone optimism. 

While I continue to like technology for growth investors in the stock market, I have also been quite vocal in not chasing some of the outrageous valuations that were assigned to these stocks by the stock market. With some of the brand-name momentum plays trading at more than 100 times (X) earnings, you have to step back, pause, and consider these metrics are ridiculous and undeserved. 

There are some analysts in the stock market coming out and advising to buy on this dip, but I’m not as convinced, especially toward the high-beta and high-valuation momentum plays in the stock market. 

The extreme valuation in the stock market is most evident in the social media space, which saw some impressive gains over the past few years even though many were not even making any money. These stocks are definitely not the kind that investment guru Warren Buffett would buy. 

Take a look at Twitter, Inc. (NASDAQ/TWTR). This has to be one of the most overvalued stocks in the stock market at this time. The company has a loyal following and is experiencing some strong revenue growth, but having to pay more than 200X its 2015 earnings is ridiculous. The stock would need to drop to below $30.00 before I would even consider giving it a look.

Chart courtesy of www.StockCharts.com 

Social media is about vision and laying out a plan for where you think the space is headed. 

If you are looking for a social media play, I would stick with Facebook, Inc. (NASDAQ/FB), with its more than one billion subscribers and vast long-term upside price appreciation potential. 

Facebook appears to have a solid game plan in mind that is focused on the user network and how to better hook up users and make money from this. The company’s current valuation of 34X its 2015 earnings per share (EPS) and price/earnings-to-growth (PEG) ratio of 1.44 is reasonable, given its potential. We are also seeing institutional buying in the stock, which helps to confirm the story.

Chart courtesy of www.StockCharts.com 

In the social media space, I also like LinkedIn Corporation (NYSE/LNKD), which connects people in the business world. The stock has plummeted to $162.00 and is way down from its high of more than $255.00. Yet in spite of the sell-off, I would still be hesitant and would wait for more weakness before jumping in. I would be looking at this play if the stock fell to the $130.00 level, which was last encountered in September 2012. Failure to hold here could see a move towards $100.00.

Chart courtesy of www.StockCharts.com 

My advice to you is to wait for potentially more selling in momentum and social media stocks before you take a closer look. 

This article was originally published at Daily Gains Letter