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I'm a value investor, which means I'm not supposed to be interested in companies trading at 10 times sales. Yet here I am, drooling over OpenTable's (Nasdaq: OPEN  ) latest quarter. So is Mr. Market, apparently, with the shares up about 25% on the day.

Here are the numbers the market cares about: Fourth-quarter revenues leaped 32% and earnings blew away analyst estimates. That's pretty heady stuff given the recession.

Now here are the numbers you should care about. First, OpenTable's installed base of restaurants rose 20% year over year, pushing its margin-rich subscription revenues up by a similar amount. Even better, though, was the 47% explosion in reservation revenues. In addition to ongoing monthly subscription revenues it pulls from restaurants, OpenTable also collects a small fee for each diner that is seated through its system. More diners are attracted to OpenTable's platform as the number of restaurants in its system grows. That's what we call a network effect, folks, and it should continue driving the number of seated diners per restaurant higher and higher.

Here's another number: 2 million. That's the total number of diners OpenTable has booked through its mobile apps on Apple's (Nasdaq: AAPL  ) iPhone, Research In Motion's (Nasdaq: RIMM  ) BlackBerry, Google's (Nasdaq: GOOG  ) Android, and Palm's (Nasdaq: PALM  ) operating systems. At this point, that's relative small potatoes compared to the number of diners coming through, but it demonstrates that OpenTable's offering is comfortably situated on mobile platforms, which are the next-generation portals to the Web.

OpenTable has several qualities we look for at Inside Value: It is a market leader, scalable, capital-light, has high switching costs, and benefits from a growing network effect. That's a winning formula that should sound familiar to investors of one of our favorite businesses: Paychex (Nasdaq: PAYX  ) .

Still, there's no real getting around the frothy valuation. Also troubling is that the company's stock-based compensation is pretty fast and loose. Nonetheless, keep your eye on OpenTable for a meaningful pullback -- for now, it will remain a great business at a bad valuation.

Senior analyst Joe Magyer owns shares of Paychex. You can now follow Joe's snarky musings on Twitter. Paychex is a Motley Fool Inside Value selection. Google and OpenTable are Motley Fool Rule Breakers picks. Apple is a Motley Fool Stock Advisor recommendation. Paychex is a Motley Fool Income Investor selection. The Motley Fool's disclosure policy takes orders from no one.

Read/Post Comments (8) | Recommend This Article (25)

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 February 10, 2010, at 1:30 PM, TMFSpiffyPop wrote:

    Great businesses rarely (for some, never) have "good" valuations... except in retrospect. Several years from now we'll look back and realize that it was actually trading at a nice discount to cash flows, and that in fact we wish we'd bought OPEN... "now"... in retrospect.

    This is the nature of Rule Breaker investing.

    Nice article anyway, Joe. Thanks. --David

  • Report this Comment On February 10, 2010, at 2:31 PM, TMFJoeInvestor wrote:

    Thanks for the note, DG. I think has OpenTable has huge long-term upside, and I could see myself investing it -- but probably not at this valuation. That's just what works for me, though I'm more flexible on growth than your average value bear. If the joint success at Rule Breakers and Inside Value proves anything, it'd be that there is more than one way to skin a cat. Or, beat the market, in this case. Just my $0.02.

  • Report this Comment On February 10, 2010, at 4:19 PM, TMFSpiffyPop wrote:

    Joe, oh I totally understand. I just want to make sure our Foolish readers hear the alternative take.

  • Report this Comment On February 10, 2010, at 7:29 PM, XMFAloha wrote:

    Love the conversation! I definitely believe that investors should gravitate toward investment styles that fit their temperament.

    The thing that appears at odds is that, as Munger says, "all intelligent investing is value investing." Therefore, if Charlie's right, Rule Breaking would have to be considered either value investing or speculation.

    I side with it being a distinct form of value investing. I've come to see RuleBreaking as a magnitude vs. frequency type of investing -- one focused on expected value rather than a simple intrinsic value. The skill is in being able to value the market possibilities that are available to the company and weigh the probability that they have the ability + vision to capture these options.

    Assuming both Google's $550M and Microsoft's $700M offers for Yelp were relatively intelligent, you start to wonder how valuable OpenTable's profitable software-as-a-service and growing rewards / reviews offering could prove to be ... especially if extended beyond just restaurant reservations. With an enterprise value under $500M, you actually start to think that OPEN might not be so expensive.

    All that being said, I long for OPEN at $25 a share ... sigh.

  • Report this Comment On February 11, 2010, at 12:22 AM, SageOrFool wrote:

    iPhone/iPad programs are opening up the floodgate for millions of extremely user friendly and useful iPhone/iPad apps that greatly simplify and beautify our lifestyles. 0penTable is only one SaaS among millions.

  • Report this Comment On February 11, 2010, at 12:30 AM, SageOrFool wrote:

    iPhone/iPad programs are opening up the floodgate for millions of extremely user friendly and useful iPhone/iPad apps that greatly simplify and beautify our lifestyles. 0penTable is only one SaaS among millions.

  • Report this Comment On February 11, 2010, at 1:01 AM, TMFMileHigh wrote:

    Andy (TMFAloha),

    >>I've come to see RuleBreaking as a magnitude vs. frequency type of investing -- one focused on expected value rather than a simple intrinsic value.

    I think that's part of it. But I also think you'll find us investing where the opportunity for misunderstanding is high.

    At Rule Breakers, we win when the underlying value-creating power of a business is superior to the *expected* value assigned by the market. This is why so many Rule Breakers look expensive, yet aren't.

    For the record: I've been bearish on OPEN because I think its failure to connect with other services is a mistake. Foursquare is a natural partner. Yelp should be, too. Even disruptors have to protect themselves from disruption.

    Still, I won't mind if I'm wrong about OPEN. Anything to keep our scorecard well up on Mr. Market.

    FWIW and Foolish best,

    Tim (TMFMileHigh and @milehighfool on Twitter)

  • Report this Comment On February 16, 2010, at 5:49 PM, henryking54 wrote:

    "The dubious honor of worst investment strategy goes to those 50 stocks having the highest price-to-sales ratios: $10,000 invested on December 31, 1951, was worth just $19,118 at the end of 2003. You'd be vastly better off with T-bills, where the same $10,000 grows to $135,185!

    The only real exceptions are during extremely speculative markets. In virtually all other market environments, these stocks are at the very bottom of the return barrel, rarely posting positive returns."

    --James O'Shaughnessy

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Joe Magyer

Joe Magyer is the advisor of Motley Fool Inside Value and Motley Fool Pro AU. A professional Fool since 2007, he now resides in Sydney, Australia. You can follow Joe on Twitter at @Magyer.

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