The Pencils IRA Project is dedicated to building a portfolio of promising businesses that can be followed and replicated by both young and new IRA investors. Each holding of the Pencils IRA Project must meet the five pillars of a "megagrower" business -- purpose-driven business, innovative products, visionary leadership, increasing cash-flow production, and strong company culture -- with significant potential to create stakeholder value and substantially beat the market over the long haul.
I recently delved into LinkedIn's (NYSE:LNKD) first two "megagrower pillars." LinkedIn is revolutionizing the social-media field for professionals, quickly passing competitors such as Monster Worldwide (NYSE:MWW) while trading at lower multiples than fellow social-media behemoths including Facebook (NASDAQ:FB) and Twitter (NYSE:T). Here are the remaining three reasons why I believe LinkedIn is poised to generate market-beating returns going forward.
3. Visionary, experienced, innovative leadership
Reid Hoffman -- who founded LinkedIn in 2003 -- continues to serve as LinkedIn's chairman after serving as executive vice president at PayPal. CEO Jeff Weiner joined LinkedIn in 2008 after spending seven years as an executive at Yahoo!. In 2011, Hoffman and Weiner both received the Ernst & Young's National Entrepreneur of the Year Award.
Weiner offers a refreshing take on what effective leadership entails:
For me, leadership is the ability to inspire others to achieve shared objectives. Managers tell people what to do. Leaders inspire them to it.
This ethos has helped create a world-class corporate culture at LinkedIn, which will be explored more in our company culture pillar.
4. Consistently increasing cash-flow production
LinkedIn's relatively low net income ($26.8 million in 2013) and sky-high P/E ratio (nearly 900), both caused by LinkedIn's extensive investments in product development, can cause some investors to write LinkedIn off as a wildly overvalued business. However, LinkedIn's cash flow production paints a different picture and demonstrates the ability of the business to generate and retain impressive amounts of cash.
Over the past four years, LinkedIn has managed to grow its base of cumulative registered members from 90.4 million in 2010 to 276.8 million in 2013. This increase in registered members has been accompanied by an average annual increase in operating-cash-flow production of 43.2% to $436.5 million in 2013. Net sales have also increased at an average rate of 58.4% annually since 2010.
Since 2011, LinkedIn's free cash flow has grown at an average annual rate of 55.5% to reach $139.3 million in 2013. This stellar free-cash-flow production -- which has helped the company accumulate $2.3 billion in cash with zero debt -- gives LinkedIn sufficient ammo to continue plowing funds into product development, acquire businesses such as Bright, and have a cushion to fall back on should the company or economy fall on hard times. (Although one could argue that a tough economic environment would actually increase the necessity and overall usage of LinkedIn's services.)
|Operating cash flow||$436.5 million||$267.1 million||$133.4 million||$54.4 million|
|Capital expenditures||$297.2 million||$182.5 million||$96.4 million||$54.5 million|
|Free cash flow||$139.3 million||$84.6 million||$37 million||($140,000)|
To contrast, Monster Worldwide -- a company that's focused solely on matching job seekers to prospective employers and that lacks a social-media networking component -- has seen its revenue decrease 18.7% since 2011. Monster's operating cash flow fell from $149.7 million in 2011 to $33.8 million in 2013 -- a 77.4% drop. Monster's struggling business, in light of LinkedIn's stellar financial performance, serves as a confirmation that LinkedIn's social-media platform is what professionals are seeking.
5. Strong company culture
"If you ask me about culture, the first word that comes to mind is transformation," says CEO Jeff Weiner. For LinkedIn's company culture, this transformation boils down to three critical points:
- Transforming the trajectory of LinkedIn's employees' careers.
- Transforming LinkedIn and realizing the full potential of the company's platform.
- Transforming the world by working toward the company's vision of creating economic opportunity for every professional around the world.
Weiner and LinkedIn's executive team hold company meetings with employees on a biweekly basis, allowing employees to interact with the company's executives in an engaging and relaxed environment. This leadership has helped Weiner garner a 98% approval rating from LinkedIn's employees on Glassdoor, with LinkedIn receiving an employee rating of 4.6 out of 5 based on more than 700 employee reviews. These glowing reviews helped LinkedIn earn the honor of Glassdoor's third-best place to work in 2014 among companies with more than 1,000 employees.
LinkedIn is in good company with its fellow social-networking peers. Twitter receives a 4.3/5 rating from employees on Glassdoor, and CEO Dick Costolo has a 94% employee approval rating. Facebook employees give the company a 4.6/5 rating, and CEO Mark Zuckerberg has a strong 97% employee approval rating. Monster Worldwide's problems extend beyond decreasing sales and cash-flow production, as evidenced by the company's 2.9/5 employee rating and CEO Sal Iannuzzi's weak 29% employee approval rating.
Foolish final thoughts
With its expanding social-media platform focused on economically empowering the world's growing base of professionals, LinkedIn arguably has the potential to become the most influential and far-reaching social network on a global scale. Few of my college peers will graduate without first starting a profile on LinkedIn and attending a workshop on how to effectively utilize LinkedIn's platform in the job hunt. By focusing on scaling its core mission on a global scale, guided by proven innovative leadership within a world-class company culture, LinkedIn offers tremendous long-term potential that I cannot pass up for the Pencils IRA Project.
The stock is not exactly cheap with a price-to-sales ratio of 16.3, but LinkedIn's performance and ongoing innovation have only served to reinforce my confidence in the company's ability to generate value for all its stakeholders (and beat the market in the process). While LinkedIn shares have more than doubled for investors since going public in July 2011, the stock's P/S ratio has been cut in half over the same period. LinkedIn's P/S is quite a bit lower than the P/S ratios of fellow social-networking behemoths; Facebook's P/S stands at 22.5, and Twitter trades at a P/S of just under 44.
Since 2010, Twitter has grown sales at an astounding average annual pace of 120.2% (more than doubling in 2013), which may partially explain why the stock commands the highest P/S ratio of the three businesses. However, LinkedIn's average annual sales increase of 58.4% since 2010 has actually outpaced Facebook's average annual sales increase of 41.3% over the same period.
Given LinkedIn's visionary leadership and innovative company DNA, I anticipate that LinkedIn will continue to expand sales at impressive rates going forward and help the stock grow into its high valuation (which is still much lower than Facebook and Twitter). I am comfortable welcoming the stock to the Pencils IRA Project this month, because I believe LinkedIn's continued leadership and innovation will lead to market-beating returns over the long haul.
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David Kretzmann owns shares of LinkedIn. You can follow David on his Foolish discussion board, Pencils Palace, on CAPS, or on Twitter @David_Kretzmann. The Motley Fool recommends Facebook and LinkedIn. The Motley Fool owns shares of Facebook and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.