Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Yelp: Why $76 May Not Be Crazy

Watch stocks you care about

The single, easiest way to keep track of all the stocks that matter...

Your own personalized stock watchlist!

It's a 100% FREE Motley Fool service...

Click Here Now

Yelp (NYSE: YELP  ) may be the most polarizing stock since The share price is up 250% since the beginning of 2013, but everybody seems to hate it. The top five articles on Seeking Alpha are all about shorting it, yet the price continues to go up. For good or bad, this is one of my favorite stocks -- not for 2014, but for the next five years. Somebody once asked me if Facebook would buy Yelp, and I responded "one day Yelp may buy Facebook." How's that for going out on a limb? Before you call the men with the white coats, hear me out.

The short thesis on Yelp is two pronged: competition and valuation. Clearly, a $76 stock that doesn't produce a GAAP profit has a high bar to live up to. The potential competition is not easy to dismiss, either. Google, Facebook (NASDAQ: FB  ) , and TripAdvisor are viable competitors. Despite this competition, however, revenue is growing dramatically fast, and there are no indications that competition is changing that trajectory. The following chart is from the investor presentation for the last earnings call:

Source: Yelp

The annual growth is impressive, but the more granular, quarterly data is more impressive. In fact, it appears to be accelerating. That's right, it's not slowing, it's accelerating from 65% to 68%. How could this be? Facebook, shortly after it launched, saw a reduction in advertising click-through because visitors were increasingly using mobile devices. Yelp, on the other hand, benefits when people access its information from mobile devices. Yelp is paid for access to the reviews that people are searching for, not clicking through to a product that is unrelated to your reason for opening the app. This is a completely different dynamic.

Source: Yelp

Unhappy clients don't spend more
One of the most interesting displays from the presentation is for active local business accounts. The year-over-year growth is 61%, slower than overall revenue, which means that existing customers are spending more with Yelp. Unhappy advertising clients don't increase their spending.

Competition seems to be the biggest issue for the company in terms of growing its business. Google and Facebook are considerably better capitalized than Yelp and the switching costs are zero for site visitors. However, since the end user doesn't have to pay for the service, why not go through a specialized niche vendor? Especially when you've created reviews for the site already.

How can the stock warrant such a high share price? 
Professional investors are looking through current estimates to what the company can produce in the future. The business can be tremendously profitable. Gross margins are 93% because the company doesn't have input costs the way a computer manufacturer would. The people who go to the website looking for reviews contribute their opinion for free. Wouldn't you like to start a business that didn't have to pay for raw materials?

Yelp could be profitable tomorrow if it wanted to be
Since operating costs are holding the company back from profitability, the company has the ability to manufacture an earnings number whenever it wants to. Today, sales and marketing expenses account for 73% of revenue. To use a technical accounting term, that's just nuts. A software company may have sales and marketing expenses as high as 40% of revenue, but not more. If Yelp's CFO decided to streamline the company and let the difference between these percentages -- $20 million -- fall through to the bottom line, at a 40% fully taxed rate, the company could have produced $0.17 per share.

While we can't say that shares of Yelp are worth $76 per, if its run rate was $0.70 and it grew profits by 60%, next year's estimate might be in the range of $1.12. If you assigned a 68 multiple to that -- since that is its revenue growth rate -- you would get a $76 share price. Maybe there's a method to the madness.

Looking for a stock you can hold forever?
As every savvy investor knows, Warren Buffett didn't make billions by betting on half-baked stocks. He isolated his best few ideas, bet big, and rode them to riches, hardly ever selling. You deserve the same. That's why our CEO, legendary investor Tom Gardner, has permitted us to reveal The Motley Fool's 3 Stocks to Own Forever. These picks are free today! Just click here now to uncover the three companies we love. 

Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2810853, ~/Articles/ArticleHandler.aspx, 8/31/2015 9:56:43 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

David Eller

I started contributing to the Motley Fool in 2013. I have held research positions at two investment banks and two hedge funds before trying more entrepreneurial ventures. I'm passionate about helping people find freedom in financial independence. Feel free to add comments and start a discussion. I hope to use these articles as forums to learn from you as well as share my opinion.

Today's Market

updated 40 minutes ago Sponsored by:
DOW 16,528.03 -114.98 -0.69%
S&P 500 1,972.18 -16.69 -0.84%
NASD 4,776.51 -51.82 -1.07%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

8/31/2015 3:59 PM
FB $89.43 Down -1.58 -1.74%
Facebook CAPS Rating: ***
YELP $24.28 Up +0.32 +1.34%
Yelp CAPS Rating: **