Shares to beat Facebook

But the eye-watering valuation – which is about 27 times last year's sales - may actually be justified by the fact that Facebook, unlike many internet companies of the past, is profitable, with a solid operating margin of about 50 per cent.

"This [valuation] suggests that Facebook is a more mature tech company than many of its peers upon listing," says Ruairidh Finlayson, an analyst at Brewin Dolphin Investment Management. "This maturity may come with slower growth rates, which has perhaps led to the lower-than-expected valuation target being set, although the valuation is still punchy."

But this high valuation may be associated with the sheer popularity of the site, which has 901m subscribers, 3.2bn 'likes' and comments and 300m user-uploaded photos as at 31 March 2012.

"For many people, Facebook is the internet," says Alexander Selegenev, executive director of Aim-traded internet company investment fund TMT Investment. "Facebook enjoys strong traffic and subscription rates. When we consider investments, the first criteria we look at is subscriber growth. If you have the audience, you can monetise them."

But how and when will Facebook monetise its audience? While plug-in gaming company Zynga generates about 12 per cent of Facebook's sales, the rest of sales stem from advertising - and advertising is not exactly doing well. In fact, just days ahead of the IPO, General Motors announced that it planned to stop advertising with Facebook as its paid ads on the site have little impact on car purchases.

Lucky Zucker

Chief executive and co-founder Mark Zuckerberg has cashed in on his company weeks after it revealed a fall in revenue and income. Revenues for the first quarter to 31 March 2012 fell 6 per cent to $1.06bn, from the previous quarter's $1.131bn. And net income fell to $205m, from $233m in last year's corresponding quarter, on the back of rising costs - particularly sales and marketing costs, which have soared to $159m in the quarter, from just $68m in the corresponding quarter in the previous year.

Also, advertisers have to see the benefit in advertising on the platform, especially since most pay premium rates for the targeted advertising - that advert for a childcare website did not find its way onto my Facebook homepage by accident. Facebook does not disclose its click-through rates (the rate at which users click on adverts on the website) but market research company Webtrends, which studied 11,000 Facebook advertising campaigns, recorded an average click-through rate of just 0.051 per cent - about half of the 0.1 per cent industry standard.

"The key issue for Facebook is the ability to monetise its users' time in a non-invasive way," says Mr Finlayson. "Facebook insists it can do this effectively; however, we have our doubts given the concerns raised by users. By plying users with advertising aimed at them based on their likes, interests or demographics, there is inevitably an invasive aspect, perhaps leading to a retraction of the valuable personal information posted on the site."

Indeed, Facebook amended its SEC filing on 11 May, adding a new risk: the mobile threat. In the amendment, Facebook cautioned that more users are accessing the site via mobile devices, through which the group does not generate any "meaningful" revenue. That said, Facebook has worked to minimise this risk through the acquisition of mobile photo-sharing application Instagram and through the recent launch of its own app store.

Advertising models aside, there are also concerns regarding Facebook's potential longevity - when Rupert Murdoch's NewsCorp acquired social network MySpace for $580m in 2005, few at the time predicted it would be disposed of for just $35m in 2011. Friendster, Napster and Hi5 are also casualties of the fast-moving social media era, and it's worth noting that they were all leading sites - once. It's possible that Facebook could follow suit in future.

"While we have seen many companies list at premium valuations, not all of them have lived up to the hype and gone on to become market leaders," cautions Dmitry Solomakhin, portfolio manager at Fidelity Funds Global Technology Fund. "In the case of Facebook, its monetisation efforts could take multiple years to bear fruit."

Indeed, Mr Finlayson advises "serious consideration" before investing, given the large unknowns, the lack of control and the "sky high" valuation.

Nevertheless, there are other, more mature, US-quoted internet businesses with proven business models that may offer a more stable investment opportunity.

eBay

Ebay's online marketplace has not been faring as well as one would have expected in times of austerity, but what has been driving growth at the online auction business is its online payments service, PayPal.

Recent first-quarter results from the group have demonstrated an improved performance at the marketplace, where sales were up 11 per cent. That said, PayPal was the star performer, with the payments business recording a 32 per cent revenue increase. In fact, PayPal had grown to account for 38 per cent of revenues in 2011, from 21 per cent in 2004. PayPal is also being rolled out in physical shops, starting with the US-based Home Depot and analysts are expecting it to become a larger part of the business. Analysts at Compass Point Research expect PayPal to account for 40 per cent of eBay's sales this year and 43 per cent next year. Compass Point has placed a price/earnings (PE)-ratio-based $46 price target on the shares, which trade at $40.6.

Amazon

"On any normal metric, this company is very difficult to invest in," declares Ben Rogoff, director at Polar Capital Technology Trust. And he makes a solid point: shares in Amazon trade on a forward PE ratio of 66 times and, more confusingly, while revenues have been growing, margins are painfully thin.

"Amazon effectively makes nothing on its retail business," says Mr Rogoff. In fact, the group has a long-term stance on its operating business - to focus on gaining market share first.

"It does not take much of a revenues loss to put physical shops out of business," says Mr Rogoff.

So, while Amazon may not be delivering the growth right now, analysts are confident that it will do so eventually. Accordingly, analysts from Deutsche Bank have a $285 price target on the shares, which are currently trading at $223.

Amazon growth estimates

LinkedIn

The professional networking site has already chalked up 150m users and has effectively changed the dynamics of the recruitment industry, by allowing employers direct access to potential new employees, cutting out the middle man. This is a crucial factor to look for in businesses operating within the digital media space - disruption. When a new service or technology effectively disrupts the industry it operates in and changes the way that sector operators, it is almost certainly worth backing.

"The site certainly enjoys that early-mover advantage," says Mr Rogoff, who adds that subscribers are not likely to delete profiles and subsequently construct new ones on rival websites.

Encouragingly, LinkedIn does not garner the bulk of its revenues from advertising, making it arguably more attractive than Facebook as an investment. According to its first-quarter results, more than half of sales are generated by hiring solutions, with another 26 per cent from marketing and the remaining 20 per cent of revenues garnered from premium subscriptions.

Important metrics to look out for in LinkedIn are renewal rates and, like other online networks, user engagement metrics. Its average monthly unique visitors have increased from about 31m in 2009 to 84m in 2011. And with professional users signing up to the site at a rate of two new users per second, LinkedIn certainly offers more longevity than its more social-oriented rivals. Indeed, JPMorgan analysts have placed a $135 price target on the shares, which currently trade at $112.

Groupon

Online coupon and daily deals website Groupon filed for its IPO last November, at $20 a share, and raised $700m. While the shares hit $31 in early trading, they are now trading at $10.7. Concerns about Groupon's ability to remain dominant in a sub-sector that has seen numerous rivals emerge as a result of the easily replicable business model have clearly weighed on the share price. In the UK alone, rivals include kgbdeals and wowcher.co.uk, while internet businesses such as Facebook and publishers Daily Mail & General Trust and Telegraph Newspapers have also launched similar websites. The crowding of this space has increased the cost of customer acquisition and maintenance at Groupon, causing it to burn through its cash pile.

Analysts at Ascendiant Capital Markets say the stock is likely to remain volatile, and it's worth noting that the moratorium on its shares from the IPO will expire on 1 June and this may cause some stock overhang. Analysts at Ascendiant have had a long standing sell call on the shares, and currently have a PE-based price target of $11 on the shares.

Google

Recent first-quarter results from the search engine giant revealed a change in dynamics for the group as it moves away from its traditional desktop-oriented business, and focuses on mobile and emerging markets. This means the business is facing a growing reliance on areas with faster growth, but not always higher prices. As such, the results revealed a 12 per cent fall in cost per click (CPC) – the price advertisers pay each time a user clicks on their adverts on Google – in the three-month period. This followed a 7 per cent decline in CPCs in the previous quarter. These declines were more than offset by a rise on the number of times users clicked on adverts, which advanced 39 per cent in the first quarter of 2012. The group has been weeding out low-quality advertisers that offer to pay larger rates. That said, Google also stands to gain from online display advertising growth. There has been a recent collaboration agreement between laggards' search engines Yahoo, AOL and MSN, which underpins their struggle to compete with Google. Moreover, there is also the growing mobile advertising space, which mobile advertising specialist Admob estimates grew in the triple digits in 2011. However, Mr Rogoff cautions that Google is not immune to "the Facebook threat". "Facebook is a real threat - although perhaps not immediately."

In fact, some 15 per cent of all Google searches are related to content from Facebook, and there is an increasing proportion of Google traffic that is coming from Facebook, too. "These two companies must be on a collision course," warns Mr Rogoff. Nevertheless, there certainly is potential for Google to regain its tech crown, and analysts have duly noted this, placing an average price target of $746.8 on the shares, which trade at $609.

Facebook investors

Yahoo's fall from grace

In the 1990s, 90 per cent of web-based searches were carried out on Yahoo's search engine. The group quietly and quickly became the dominant search engine and, by 2008, its gross revenues peaked at $7.21bn. Last year, the group's annual revenues were just $4.68bn. In fact, revenues have been declining for the last 12 consecutive quarters. A new chief executive was installed in January - former head of mobile payments business PayPal, Scott Thompson. However, after just three weeks in the job, he had to deliver a nasty set of 2011 results and, even more worryingly, he failed to deliver any clear guidance on exactly how Yahoo! plans to resurrect the business.

But what caused this spectacular fall from grace?

Many industry insiders blame Yahoo's demise on its internal culture. The group never really classified itself as a technology company, but as a media company. This culture meant that programmers did not have free rein to develop and innovate - and all technology companies have to innovate and take risks. So when Google started gaining traction in the same space, and began earning revenues for advertising placement based on keyword searches, Yahoo still opted to focus on search and its core revenue source - banner advertising.

In its most recent results, Mr Thompson said he intends to focus on data gathering - specifically web traffic and user interests - although it may be a case of too little too late.

"Yahoo is in a special situation," asserts Mr Rogoff. Indeed, Yahoo's core business - its search engine - is losing traction and grip of its existing users, largely due to growth in Google's market share.

The lack of clear direction for the group has rattled analysts, but while shares in Yahoo are now trading at just $15 (half of the levels in 2007), there is value in Yahoo's Asian assets and there are talks of a possible split of the business. The group owns 40 per cent of China's business-to-business trading platform Alibaba and analysts say a sale of this could drive Yahoo's share price to $20.

Following recent revelations about the group's management, a sale could be more imminent than expected.