Why would otherwise intelligent, savvy financial professionals invest in a product that they know is over-valued? The answer is simple, they think there is someone dumber than them who will buy it. Called The Greater Fool Theory, this is one of the main reasons a small start up that has never turned a profit can suddenly be flush with millions of dollars and little to show for it. The market will eventually correct itself, leaving the poor souls still holding onto shares to foot the bill. A single company experiencing this kind of correction will often spur other companies in their industries to experience the same fate, wiping out massive amounts of capital and even bankrupting entire industries. When the Internet "bubble" burst in 2000, countless .com companies were lost in its wake. In 2011, the Internet industry has recovered and is flourishing, at least for the time being. Here are the six companies most likely to bring that to a screeching halt and burst the bubble all over again.
One of the best indicators of a company's future profitability is pretty self-explanatory; Find out how much money are they making now! It's crazy, right? Some say it's a system used only by fuddy duddy nobody investors like some guy in Omaha. It might not be particulary innovative or sexy, but it's the most reliable sanity check on a market's growth. That's why it's kind of surprising that Digg.com is being implicitly valued by investors as being worth over $160 million. That's right, Digg.com, also known as the site that has struggled to make any money at all! Having only recently turned in a paltry revenue of $8.5 million dollars, they spent over five years trying to figure out how they were even supposed to make money. Economic indicators aside, it can't be a good thing that many users left with the launch of v4 last year.
LinkedIn is better known as the Facebook that your boss made you join or that page everyone updates once every three years. LinkedIn has risen from a sea of competitors and is currently seen as the premiere business social networking tool. Unlike most social networking sites, LinkedIn has actually convinced companies to pay for its service, bringing down a healthy revenue in the $160 million range. A respectable number for any company, but LinkedIn is valued at $2.5 billion, roughly 15 years worth of earnings. While that level of capitalization is only a little on the high end when compared to its peers, it starts to look less attractive when you realize LinkedIn is sitting in a crowded marketplace that could be shrunk to virtually nothing with a couple lines of code and a well-executed Facebook update. There is also the fact that the word "LinkedIn" has never been uttered without someone nearby rolling their eyes.
Twitter has come a long way in only a few short years. It's an incredible accomplishment for a site to go from a joke about vaginas and a platform for celebrity feuds to a world-shaking communication device that has brought more than a few governments to their knees. This is an impressive feat that has led to a valuation in the neighborhood of four billion big ones. It would be an even more impressive feat if Twitter had made any money whatsoever. However, investors can rest assured that they are totally working on figuring out that making money thing.
Chicago-based Groupon exploded on to the scene in 2008 and instantly made your Grandma's coupon-clipping appear even more quaint. With deals offering up to 90% off meals at select restaurants, spas, skydiving, and pretty much anything you can imagine, the site rocketed to the top of yuppie weekend plans everywhere. The model is shockingly simple: a business will offer outrageously steep discounts in the hope that it will eventually drive greater business, and Groupon pockets a percentage. It's an elegant system that has led to Groupon being valued at a rumored $15 billion range. Unfortunately, it's an elegantly simple system, which means it almost instantly accumulated a whole raft of competitors -- more than a few of which are boasting some pretty powerful allies. Though they originally rebuffed a $6 billion buy-out offer, it's looking pretty attractive in a market where competitors can steal margins in only a few short months with only a minimal start-up cost.
The top producer of annoying games your mom plays at work and your girlfriend won't stop bothering you about, Zynga has cornered the market on sadistically addictive social network games. They've already managed to rocket past the revenue of many traditional gaming shops, and Farmville is currently more popular than a Mario and Master Chief love child. It's no wonder that Zynga is currently valued at $5.7 billion, not bad for a company that makes video games that are completely ignored by most regular gamers. Despite their impressive earnings of roughly $350 million, $5.7 billion is a lot of money for a system that is completely dependent on another company's software that has little to no obligation to support you.
There is perhaps no better demonstration of the greater fool theorem -- or the fact that a bubble might be forming -- than the valuation of Facebook, which now stands at an absolutely staggering EIGHTY NINE BILLION dollars. (Yes, billion, with a "b"). It's especially illuminating when a recent Bloomberg poll shows that next to no one thinks the company is actually worth even the $50 billion offering from Goldman Sachs. Yet firms and individuals are laying out enough money to buy the entire United States Navy aircraft carrier fleet to get a piece of the action -- not because they actually think it's worth that, but because they're all waiting on the greater fool.
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