Federal Reserve sees social media and biotech valuations as "substantially stretched"

Peter Spence
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The Federal Reserve has expressed concerns that biotech and social media bulls have gone too far (Source: Getty)

The Federal Reserve has joined the voices calling out biotech and social media stocks as over-priced.

In its Monetary Policy Report, the Fed says "valuation metrics in some sectors do appear substantially stretched," singling out smaller firms in both social media and biotechnology.

So what valuation metrics might the Fed be using? The most popular tool to assess if a stock is well valued is the price-to-earnings ratio - but many of these firms have no earnings to speak of.

That doesn't necessarily mean they're over-valued - many of these companies work at the frontier of technological innovation and are too young to have started making money, often taking a loss as they invest in R&D. Price-to-sales is another popular tool, but again, isn't that useful for faster growing firms.

Traditional valuation metrics haven't been very useful so far, so perhaps the Fed's words should be taken with some caution. For social media specifically, it may make more sense to gauge a stock's strength by the number of engaged users a company has, or by its share of the online advertising market by spending. Even price to employee may make more sense than standard measures.

The Fed says those biotech and social media stocks remain stretched "despite a notable downturn in equity prices for such firms early in the year". The Fed's comments have sent stocks in each sector even lower. Twitter, Facebook, and LinkedIn all traded lower following the release, as did the iShares Nasdaq Biotechnology ETF.

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