LinkedIn: Social Media Meets Reality

Last Friday, LinkedIn  (NYSE: LNKD  ) lost over 12% of its sky-high value after management commented that revenue for the quarter and full year would likely come in shy of analysts' consensus estimates. Diehard LinkedIn investors could have prevented this tragedy if only they would have kept up with the trend data. One harbinger of a fall was the ridiculous P/E ratio of 775 beforehand, and 675 (100-point P/E drop) afterwards. Was it so long ago that we forgot the last Internet bubble? A closer and much less painful review of LinkedIn's trend data would have tipped off investors to a coming correction.

Metric

March 31, 2013

Dec. 31, 2012

Sept. 30, 2012

June 30, 2012

March 31, 2012

Revenue

$324.71

$303.62

$252.03

$228.21

$188.46

% change (YOY)

72%

81%

81%

89%

101%

Source: Capital IQ. YOY = year over year.

While revenue had been rising by triple-digit percentages since its initial public offering in May 2011, the last four quarters exhibited only double-digit growth. Importantly, the year-over-year change has been slowing sequentially. Even analysts' estimates of $360 million for next quarter would result in a "mere" year-over-year increase of 57.75%. LinkedIn's estimate in the range of $342 million to $347 million would result in a smaller 52% rise. This downward trend is important because revenue in the most important metric from which other metrics and ratios are derived: LinkedIn's valuation comes nowhere close to its price/earnings multiple.

In the past, my research has incorporated a Motley Fool Earnings Quality score that taps into a database that ranks individual stocks. The database designates an A through F weekly ranking, based on price, cash flow, revenue, and relative strength, among other things. Stocks with poor earnings quality tend to underperform, so we look for trends that might predict future outcomes.

LinkedIn doesn't have an EQ score yet because it hasn't yet joined one of the S&P Indexes, but we might surmise that it would be a bottom dweller due to this valuation. The model downgrades stocks that are overvalued relative to their metrics. Based strictly on the revenue projections alone, I estimate that LinkedIn is likely to consolidate further. This stock is so far ahead of itself, if it were a track star it would have lapped itself. Do not pass "Go," do not collect $200. Sell, and collect $175 while you still can.

Monster Worldwide (NYSE: MWW  )
Monster is another social media darling that was in the financial news on Friday, as it reported EPS of $0.08, $0.01 ahead of consensus estimates. The stock soared over 5% to $4.91 on the news despite lower year-over-year EPS and revenue. TMF EQ score database ranks Monster as an "A" stock. Other metrics that highlight positive trends are listed below.

Metric

March 31, 2013

March 31, 2012

Gross margin

54%

51%

Operating margin

7%

4%

Days deferred revenue

153

151

Price/sales ratio

0.6 times

1.2 times

Total shares (millions)

111.402

114.139

Source: Capital IQ.

Notable are the days deferred revenue, or DDR, of 153 days last quarter. This means that Monster's backlog of projects to attract and hire qualified candidates to satisfy its clients' staffing needs is very strong. It also indicates that the hiring trends of many companies may have turned the corner. Some of Monster's metrics are of concern, but based on the margin improvements, DDR numbers, and the improving employment trends in the U.S., things appear to be picking up.

Yelp (NYSE: YELP  )
In its 10-Q dated May 3, Yelp states that it connects people (as patrons) with great local businesses. Thus, it seems Yelp has a business model that is the inverse of Monster: To connect people (as employees) with great businesses. In its report, Yelp stated: "As of March 31, 2013, we are active in 54 Yelp markets in the United States and 46 Yelp markets internationally. This footprint represents a fraction of the potential domestic and international markets that we are currently targeting for expansion."

The business model appears to have great potential, first because of the small fraction of markets in which it currently operates, and second because two-thirds of users access Yelp via their mobile devices, and we know that mobile is not going away anytime soon. Some of Yelp's metrics also are appealing: The company's gross margin is very high at 93% and it actually bumped up from 92% year over year. And while the sales and marketing component of G&A expenses are pretty high, they dropped from 69% to 61% of revenue. Revenue rose to $46.12 million, up 68% from the same quarter last year. As opposed to LinkedIn, the change in revenue growth is rising. Yelp makes its money from advertising content and advertising revenue is based on unique visitors (the number of people that use the application). Advertisers and visitors are both growing -- local advertisers improved from 78% to 85% of revenue.

Yelp hasn't figured out how to be profitable yet, but it's only a matter of time before the revenue overcomes the costs. The EBITDA margin over last 12 months shows significant improvement from negative 13% a year ago to  negative 3% most recently. Free cash flow and operating cash flow are both positive. Net income improved from negative $9.8 million to negative $4.8 million, and EPS similarly improved from a loss of $0.31 to a loss of $0.08 a share. The TMF EQ model does not rate Yelp, but because of the improving financials we could claim a healthy score. However, these positive trends could handsomely reward investors willing to be patient.

Foolish bottom line
The rise of social media has shown promise to millions of investors looking for the million-dollar baby. But the "here today, gone tomorrow" mentality of the public underscores the importance of tracking the numbers before we invest. As always, Foolish readers should base investment decisions on earnings quality.

It's incredible to think just how much of our digital and technological lives are almost entirely shaped and molded by just a handful of companies. Find out "Who Will Win the War Between the 5 Biggest Tech Stocks?" in The Motley Fool's latest free report, which details the knock-down, drag-out battle being waged by the five kings of tech. Click here to keep reading.


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