Companies in digital advertising like social media and search engines because they generally carry high gross margins. But one company has risen above the rest by tackling the advertising angle from several different sides. LinkedIn (NYSE:LNKD) posted a gross margin of 87% last year, better than Facebook (NASDAQ:FB), Twitter (NYSE:TWTR), and Google (NASDAQ:GOOG) (NASDAQ:GOOGL).
Impressively, LinkedIn has maintained -- even grown -- its gross margin as its revenue grows at a rapid pace. Let's take a look at some of the trends going on at LinkedIn, and how it's been able to achieve such a high gross margin.
Revenue doesn't slow down
LinkedIn has posted a record quarterly revenue for 21 straight quarters. The only other company in this article with a string of sequential revenue improvement that comes even close is Twitter, which has at least nine consecutive quarters. But Twitter's revenue is still less than LinkedIn's.
One of the main reasons LinkedIn hasn't suffered from as much seasonality as Facebook or Google is because it promotes premium services to its members. Its Talent Solutions business for recruiters continues to grow, improving sales 41% year over year last quarter. The segment still accounts for the majority of revenue. Premium subscriptions for job seekers grew 38% last quarter, but only makes up less than 20% of revenue.
LinkedIn's fastest growing segment is its Marketing Solutions business, which focuses on advertising. The segment grew 56% last quarter, and with the seasonal nature of advertising, the bigger the segment gets the less likely LinkedIn will keep its revenue record streak alive.
In fact, analysts aren't expecting another record quarter for the first quarter of 2015. Currently, the consensus estimate sits at $635.7 million, compared to LinkedIn's reported revenue of $643.4 million. Still, analysts expect LinkedIn to continue growing revenue at a strong pace of 34%.
While analysts expect LinkedIn's streak of record revenue results to come to an end this year, the consistent growth has helped improve gross margin.
Where does LinkedIn separate itself from the pack?
With its phenomenal revenue growth, LinkedIn has managed to keep its cost of revenue from growing faster than its sales. Even with that growth, LinkedIn's cost of revenue is remarkably low, despite the fact that most of its costs are similar to its competition.
The biggest portion of LinkedIn's cost of revenue is salaries paid to employees for production operations, customer support, infrastructure, and advertising operations teams.
Comparatively, the biggest cost of revenue for Twitter and Facebook are related to their data centers and servers. Due to the high amount of traffic on each website, their web hosting costs are significantly higher than LinkedIn's. Google also has to spend significant amounts on its data centers, but it also pays traffic acquisition costs to drive traffic to its search engine, which make up the majority of its cost of revenue.
Minimizing these expenses, has led to a higher gross margin at LinkedIn. Of course, as LinkedIn page views increase through international expansion and a focus on more engaging content, LinkedIn may see its Web-hosting costs increase as a percentage of costs of revenue.
What does this all mean for investors
A high gross margin means LinkedIn's sales are particularly valuable. While LinkedIn is currently spending a lot of money on product development, as well as sales and marketing, both investments naturally carry some leverage. In the long run, investors should expect those expenses to become a smaller percentage of revenue, despite their consistent combined 50% of revenue over the last three years. That's when a high gross margin will shine through to the bottom line.
Currently, however, LinkedIn trades for a price-to-sales ratio of less than 15. Comparatively, Twitter trades for a PS ratio over 21, and Facebook trades for nearly 18 times sales. What's more, LinkedIn is profitable and growing earnings per share faster than its revenue. In that light, it seems undervalued compared to its peers.
Adam Levy owns shares of Apple. The Motley Fool recommends Apple, Facebook, Google (A shares), Google (C shares), LinkedIn, and Twitter. The Motley Fool owns shares of Apple, Facebook, Google (A shares), Google (C shares), LinkedIn, and Twitter. 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.