Saturday, January 14, 2012

Social Networks are "Over-Valued?"

As Facebook prepares for a much-expected initial public offering, it might be worthwhile to review the difference between value and "valuation." If you follow the history of technology innovation, a good general principle is that observers, including market researchers, tend to over-estimate the near term impact and growth, and under-estimate the longer-term growth.

Another way of putting matters is to note that important new technologies take longer to achieve dominance than people expect. Important mass market technologies take longer to hit critical mass than most expect, but then seem to hit an inflection point and accelerate suddenly. It's an "S" curve.

Market valuation, though, also seem to under-estimate value in the early phases, than over-estimate after the inflection point. In other words, sentiment is too frothy, once a new technology has clearly gotten traction, and is on the way to mass adoption. At some point, overly optimistic expectations come back down to align with underlying value.

If it happens on a widespread scale, you get an investment "bubble." So some would say there is a danger now of a valuation overshoot, to be followed by a correction, in the "social" software business.

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