Here's Why You Might Want to Think Twice About Yelp Inc

While investors praise Yelp (NYSE: YELP  ) for a nice quarter, all fears regarding a recent probe and business practices have gone out the window. Essentially, there's a big question of uncertainty hovering over Yelp, and while the company grows fast, peers such as LinkedIn (NYSE: LNKD  ) and Facebook (NASDAQ: FB  ) would likely make far better investments.

A strong quarter indeed
Yelp's stock soared nearly 10% after the company's revenue grew 65.6% in the first quarter to $76.4 million, thus beating expectations. In the first quarter, the company saw major improvements in all notable areas of its business, including a 95% increase in international traffic.

With the stock losing more than one-third of its value since March, many believe Yelp is a golden investment opportunity. Yet, there is one overhang that could make Yelp's recent gains look like a trap.

Don't forget, this could be serious
Just last month a Wall Street Journal probe, combined with an article in the LA Times, unmasked a slew of problems related to the legitimacy of Yelp's review and its pushy business practices. Reportedly, Yelp has been accused of hurting the ratings of local businesses, who refuse to advertise on the site, and removing bad reviews for paying businesses. It's worth noting that local business accounts grew 65% to 74,000 in the first quarter.

With that said, there is a large-scale investigation ongoing into the origination of reviews, their legitimacy, and it could lead to litigation. To get an idea of its scale, there have been more than 2,000 FTC complaints filed against Yelp, and the company reported, on average, six subpoenas per month.

Better options available
Yelp trades at 20 times sales, and while the above allegations might be nothing, it does pose a significant risk on a stock that's priced for perfection. Therefore, LinkedIn and Facebook might provide a better opportunity for investors who want to be in this space.

LinkedIn is currently down 30% in 2014 and even lower today after the company was criticized for its full-year revenue guidance. Yet, with $2.07 billion in revenue expected, LinkedIn should grow 35% this year .

Furthermore, its largest segment, talent solutions, is still growing at a 50% annual clip. Therefore, with LinkedIn trading at a near 50% discount to Yelp in terms of sales, and also profitable with operating margins of 3.1%, it likely presents more upside potential.

Facebook trades at a multiple that is similar to Yelp, at 17.4 times sales, but with an operating margin of 40% and 60% growth, Facebook is much more profitable. Not to mention, Facebook is still in the infancy of monetizing its near 1.3 billion monthly active users.

In 2014, Facebook has announced both a new video advertising service, which will open it to new advertisers, along with a payment processing system. Therefore, with nearly $9 billion in annual sales, Facebook still has a lot of opportunities for monetization, and to create higher profits.

Final thoughts
In the social media space, we are often prisoners of the moment and quickly forget recent events due to eye-popping headlines. In many ways, Yelp is a great example, as the allegations against it are severe, challenging the legitimacy of its entire business model. And if the claims prove true, its enormous valuation means it could fall a long way.

Hence, with there being many good opportunities within this space, investors might want to think twice about chasing Yelp's recent gains.

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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.

  • Report this Comment On May 05, 2014, at 5:00 PM, mpr120 wrote:

    Perhaps you should keep your opinions to yourself - Most of your advise is incorrect and I believe you are a shorty.,...Go Away

  • Report this Comment On May 05, 2014, at 8:51 PM, sanoran wrote:

    Yelp is an extortion scam, -plain and simple. Small businesses are always afraid of the Yelp 'salesman' calling. He will tell them about their 'bad' review problem, and offer them a solution. Basically, Yelp will sell them 'protection' from bad reviews for a fee.

    The Mafia sold protection the same way. First a gang member would come and rough up the small business, Then another member of the mafia would come and offer protection.

    So how can Yelp get away with it? Two reasons. Most people never care who writes the reviews they read. Second, the small businesses Yelp (Stoplemann) is praying upon are just too small and weak. They are too stressed by their own life to have any energy left to fight back. Yelp salesmen are trained to single out really weak small businesses (they never go after big chains or big establishments with good lawyers).

    Yelp's money is blood-money, -it is money extorted from the most hardworking people in the country, ... poor Christians being exploited by clever ... you know who :)

    Eventually, some clever lawyer will file a class-action suit and put an end to it. He will point out the difference between free-speech and slander.

    Or some restaurant owner would take matters into his own hands (Jeremy Stoppleman probably has body-guards, ... like a mafia boss) already.

  • Report this Comment On May 06, 2014, at 11:32 AM, steve777999 wrote:

    It's funny how a company that makes sure it's reviews are legitimate, gets accused of just the opposite by the news media. YELP explained (as much as they could without being sued), that some reviewers try to pump up their own listings and because YELP called them out on that after tracing their ip address reviews back to the same companies that were reviewing themselves, they get blamed for being unfair. That's what Borders Books, probably thought about Amazon too and it's up over 20,000 %, with nearly 300 % of that being in the last 5 years. I'd advise to catch this new rocket now before blastoff. YELP is getting some big partners because of it's credibility and would be a good fit for many big companies. It's growth is great and I think it's commendable that they focus on growth to maintain leadership and attractiveness in these local, mobile, and soon global reviews. Just the way Amazon focused on growth in it's early years. Great buying opportunity on YELP right now while the naysayers are bashing it, (probably to buy it cheap for themselves, lol).

  • Report this Comment On May 06, 2014, at 4:20 PM, geoinseattle wrote:

    I agree wholeheartedly with sanoran. I have a small business and was treated to the sort of thuggery sanoran described. Yelp had a very odd way of monetizing their advertisers, you pay to have an ad put on a competitors yelp site. Or you can pay to be the first one on the list in a user search. I asked them what would happen if my competitor paid to be the first as well and they said it would alternate. I don't think they have found a valid way to monetize their model, much like the other techs. The "reviews" are merely opinions of users and the time will come when the producers lose interest in opining unless something is really bad. Why would I, as a small business owner pay to advertise on something that potentially has something bad to say about my business. Just saying....

  • Report this Comment On May 07, 2014, at 8:50 PM, SeattleDouglas wrote:

    Federal District Court Complaint against - Yelp Inc.

    Google Search -

    Kimzey v. Yelp Inc.

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Brian Nichols

Brian Nichols is the author of "5 Simple Steps to Find the Next Top-Performing Stock: How to Identify Investments that Can Double Quickly for Personal Success (2014)" and "Taking Charge With Value Investing (McGraw-Hill, 2013)". Brian is a value investor, but emphasizes psychology in his analysis. Brian studied psychology in undergrad, and uses his experience to find illogical value in the market. Brian covers technology and consumer goods for Motley Fool. Brian also updates all of his new and current positions in his Motley Fool CAPs page. Follow Brian on Twitter and like his page on Facebook for investment conversations and recent stories.

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