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Ignore Facebook: Here's a Better Stock

By Andrés Cardenal - Feb 17, 2016 at 4:45PM

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Facebook is doing great, but this company offers more upside potential at current prices.

Image Source: LinkedIn.

Facebook (META 0.22%) is an amazing success story -- the social network founded by Mark Zuckerberg is producing impressive returns for investors on the back of rock-solid financial performance. However, investment decisions are about the future, and past performance is no guarantee of future returns. On a forward-looking basis, LinkedIn (LNKD.DL) could be a better investment than Facebook.

A tale of two social networks
Facebook and LinkedIn could hardly be going in more different directions in 2016: Facebook stock has gained nearly 35% year-to-date, while LinkedIn stock is down by a breathtaking 63% in the same period.

It's easy to understand why Facebook is doing so well: the company has a gargantuan user base of 1.59 billion monthly users, an increase of 14% year-over-year during the fourth quarter of 2015. Management is also doing a great job at monetizing that user base: total revenue grew 44% last quarter, reaching $17.93 billion.

Even better, Facebook still has a lot of room for growth, not only on its main platform but also in services such as Instagram and WhatsApp. Management said in the latest conference call that Instagram passed the 400 million users barrier in September, gaining 100 million new users year-over-year. As for WhatsApp, it ended 2015 with over 1 billion users.

To put these numbers in perspective, Twitter (TWTR 0.54%) reported only 305 million monthly users when excluding SMS fast followers in the December quarter. This represents an increase of only 6% year-over-year, and it's also a decline from the 307 million users Twitter reported in the September quarter. Looking at these statistics, it's really no wonder why investors are increasingly disappointed in Twitter stock.

The problem with LinkedIn
LinkedIn is doing quite well on the user front. The company ended the fourth quarter of 2015 with 414 million users, a strong year-over-year increase of 19%. Member page views grew 26% versus the same quarter in the prior year, so engagement is also moving in the right direction. Besides, mobile activity grew three times faster than overall member activity last quarter, and nearly 57% of all traffic to LinkedIn is now coming from mobile, a crucial growth segment in the industry.

LinkedIn also announced a big increase in revenue of 34% during the December quarter, while sales during the full year grew 35%. This means the recent decline in LinkedIn stock can hardly be attributed to the company's remarkably healthy performance in 2015.

However, the main drawback is that sales guidance for 2016 came in materially below expectations. Management is expecting revenue during 2016 to be in the range of $3.6 billion to $3.65 billion, which would represent an increase of 20% to 22% versus 2015 levels. Based on this forecast, LinkedIn is clearly anticipating a deceleration in growth over the coming year. 

Management said during the conference call that LinkedIn is feeling the impact from challenging economic conditions in the EMEA-Europe, Middle East, and Africa-and-Asia-Pacific regions. Besides, the company is putting quality over quantity when it comes to funding new growth ventures, so a more selective and concentrated approach to innovation could be slowing revenue growth in the middle term.

Why I prefer LinkedIn over Facebook
Facebook is a top quality company priced for demanding expectations. LinkedIn, on the other hand, seems to be quite undervalued. Facebook carries a price to sales ratio around 16.2 -- that's more than three times the price to sales ratio the market is assigning to LinkedIn, in the area of 4.4.  Even Twitter is more expensive than LinkedIn with a price to sales ratio of 4.8; this doesn't really make much sense, considering LinkedIn is doing materially better than Twitter when it comes to users.

Besides, Facebook makes almost all of its sales from online advertising, meaning the company has to compete against industry giants such as Alphabet (GOOG 0.19%) (GOOGL 0.33%) and its powerful Google online advertising business. Alphabet reported that Google has 7 different platforms with over 1 billion users as of the end of 2015: Search, YouTube, Android, Maps, Gmail, Chrome, and Google Play. In terms of revenue, Facebook is just 24% the size of Alphabet, so even if Facebook is growing at a remarkable speed, it still comes well behind Alphabet in its core business.

LinkedIn makes nearly 21% of revenue from online advertising, but talent solutions for corporations account for a much larger 62% of revenue, and the remaining 17% of sales comes from premium subscriptions for users. This means that LinkedIn is more about human resources and professional networking, not so much online advertising -- so the company doesn't need to compete against a juggernaut such as Alphabet to the same degree that Facebook does.

LinkedIn is the top dog in its main business, and the company benefits from the network effect, meaning that users and corporations attract each other to the platform. The company has 42,987 corporate solutions customers as of the end of 2015, an annual increase of 29%, so LinkedIn has clearly proven to businesses around the world that it has a valuable proposition in human resources. 

LinkedIn stock is substantially cheaper than Facebook. Even if growth is slowing down, everything indicates that LinkedIn is well on track to consolidating its leadership position as the leading platform for online human resources and professional contacts in the years ahead. At current prices, I believe LinkedIn offers far more upside potential than Facebook.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Andrés Cardenal owns shares of Alphabet (A shares), Alphabet (C shares), and LinkedIn. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, 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.

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Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
$122.08 (0.33%) $0.40
Meta Platforms, Inc. Stock Quote
Meta Platforms, Inc.
$180.89 (0.22%) $0.39
LinkedIn Corporation Stock Quote
LinkedIn Corporation
Twitter, Inc. Stock Quote
Twitter, Inc.
$44.50 (0.54%) $0.24
Alphabet Inc. Stock Quote
Alphabet Inc.
$122.88 (0.19%) $0.23

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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