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The recent sell-off of high flying social media stocks such as Twitter (TWTR - Analyst Report) highlight intensifying investor concerns over their growth prospects. Although the stocks promise supernormal growth, lack of visibility into their operations and source of revenues increase investment risks.

Social media stocks depend on advertisements and subscription-based models that are primarily tied to the growth in user base and engagement. Hence, these stocks are largely dependent on advertising spending, which again relies on the overall macro-environment as well as the effectiveness of the social media in targeting users.

Marketers tend to prefer those social media platforms that cater to a diversified and growing user base. User engagement becomes more important as the platform gets bigger and user growth slows down. Social media companies are required to frequently update their products and services in order to limit the churn rate.

Despite their inherent risks, these stocks often trade at lofty valuations, which lacks justification and defy common sense. Although short-term investors find them attractive for their high flying ability, the high premium compels value investors to stay on the sidelines.

However, we believe that the recent sell-off makes some of these social media stocks cheap for value investors. We pick two such stocks that have strong growth potential:

Facebook (FB - Analyst Report) – Best of the social media picks, we believe that the recent decline in Facebook’s share price is unwarranted due its impressive first-quarter 2014 results. This Zacks Rank #2 (Buy) stock has strong growth potential in mobile, which accounted for 59.0% of its advertising revenues in the recently concluded quarter.

Mobile Monthly Active Users (MAUs) surged 34.0% year over year to 1.01 billion, a significant growth over a short span of time. We believe that Facebook’s position in mobile will continue to improve due to new products that will drive user engagement and attract advertisers. Additionally, robust growth in Instagram and WhatsApp user base, strategic acquisitions and initiatives such as Internet.org are compelling positives.

Yelp (YELP - Snapshot Report) – Yelp is expected to benefit from strong growth in active local business accounts as well as improving mobile customer engagement. This Zacks Rank #2 stock diversified its revenue stream by offering new features such as the revenue estimator, Yelp platform and call-to-action.

We remain encouraged by the company’s international expansion (Japan, Mexico and Portugal in 2014) which in turn will boost ad revenues. Moreover, Yelp’s strategic partnerships with Yahoo! (YHOO - Analyst Report) and YP will further increase customer engagement.

Yelp is set to report first-quarter 2014 results on Apr 30.

Conclusion

We believe that any improvement in the fundamentals of social media stocks will boost investors’ confidence in the near term. Investors will eagerly await growth in user engagement, which will be the key catalyst in attracting advertisers going forward.

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