Will Google Inc's Algorithm Update Hurt RetailMeNot Inc?

Some are speculating that RetailMeNot's hits have already decreased 33% following Google's latest algorithm update. Should RetailMeNot investors be worried?

May 25, 2014 at 11:30AM

RetailMeNot (NASDAQ:SALE) shares were crushed almost 19% on Thursday after reports that the company was among the biggest losers following algorithm changes made by Google (NASDAQ:GOOGL)(NASDAQ:GOOG). While the algorithm changes at Google may jeopardize the digital coupon provider's ability to take full advantage of search engine optimization in the short-term, RetailMeNot's long-term prospects remain intact. 

What is the algorithm update? 
This week Google rolled out Panda 4.0, an algorithm update that has been discussed since March. Google Panda is a filter implemented by Google in 2011 to limit the ability of sites with poor-quality content, such as spam, from getting displayed toward the top of queries made on Google. Google updates the Panda filter every month, so an update to Panda was expected. 

Legitimate sites are, however, sometimes affected by the Panda updates and other changes in Google's algorithm. This time around, eBay and RetailMeNot are purportedly the main sites, who have seen their search engine hits decrease as a result of the Panda 4.0 update. It seems that RetailMeNot was caught in the estimated 7.5% of search engine queries affected by the Panda 4.0 update. 

The Search Engine Journal notes there are accounts of websites affected by previous Panda updates now "seeing significant recoveries." In addition, several accounts suggest "the update has indeed been a little softer and more generous to sites, especially those previously affected."

Does this really impact RetailMeNot?  
Approximately 65% of RetailMeNot's website traffic is driven through search engines. Search analytics firm Searchmetrics claims that RetailMeNot's total hits fell 33% after Google's Panda 4.0 update. RetailMeNot responded by issuing a press release stating "these reports greatly overstate the impact on RetailMeNot.com." The press release also emphasizes the crucial point that RetailMeNot has already experienced numerous algorithm changes from various search engine providers since the company's founding in 2007. In other words, this is not something new. 

Search engines regularly update their algorithms, causing website traffic to fluctuate. Innovative and responsive businesses will respond accordingly and adjust search engine optimization strategies. This is a pretty simple concept but, as in this case, it can provide an outlet for shortsighted traders to panic and jump ship.  

Perhaps most importantly, RetailMeNot's press release notes, "It is too early to judge any potential impact of the latest Google algorithm change." Speculation about the Panda 4.0 update's impact on RetailMeNot is just that: speculation. That hasn't stopped the market from hammering shares of RetailMeNot to their lowest levels since the company's IPO in July 2013. 

RetailMeNot appears strong as ever 
RetailMeNot continues to grow at impressive rates. In the company's most recent quarter, total sales expanded 51% to $61.3 million. Sales from mobile devices increased 127% year over year to $9.3 million for the quarter. Sales growth shows no signs of slowing, and the company continues to plow cash into research and development. This quarter, RetailMeNot increased research and development funding by 79% year over year to $10.7 million. 

RetailMeNot continues to produce positive free cash each quarter, which has allowed the company to build a cash hoard of $196.5 million with only $24.5 million in debt. 

RetailMeNot also has a strong employee culture as evidenced by reviews on Glassdoor. Employees give the company a solid 4.2/5 rating on Glassdoor. Founder, president, and CEO Cotter Cunningham earns an 89% employee approval rating, reflecting Cunningham's belief in developing an innovative culture and rewarding employees. "We believe people work hard for us," says Cunningham, "so we need to work hard for them."  

Foolish bottom line 
Even after Thursday's sell-off, RetailMeNot trades at a premium price of 5.8 times trailing twelve month sales. Investors without a stomach for volatility -- as evidenced by how the market treated the stock based on purely speculative reports -- should avoid RetailMeNot at this point. The stock will likely trade at a premium considering the business increased sales at an average of nearly 88% annually over the past four years.

If RetailMeNot can continue to expand sales more than 30% annually over the next three to five years, there is a good chance the stock will be able to grow into its valuation. Whether you see a bright or bleak future for RetailMeNot, concerns about Google's Panda 4.0 update may not justify selling the stock. 

Foolish investors should focus on the health of the underlying business. If the Panda 4.0 update really impacts RetailMeNot as negatively as some are speculating, I would be surprised if RetailMeNot is unable to devise a solution to accommodate and improve upon Google's latest algorithm.

For now, RetailMeNot's business remains intact and the company's actual performance has -- up to this point -- been stellar. I see no reason to panic. 

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David Kretzmann owns shares of Google (C shares) and RetailMeNot. The Motley Fool recommends Google (A shares), Google (C shares), and RetailMeNot. The Motley Fool owns shares of Google (A shares) and Google (C shares). 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.

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Jun 12, 2015 at 5:01PM

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't 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.

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