Even after acknowledging its strong monetization system, LinkedIn Corp (NYSE:LNKD)’s current 672 P/E ratio doesn’t look healthy or sustainable to me. Yet, the stock price keeps rising like there’s no tomorrow. What is causing this overvaluation and could this be a disaster in the making or just another growth IT stock?
Super overvalued or high growth stock?
With the P/E ratio approaching 700 and the stock price at its all-time high, LinkedIn is clearly overvalued. The question is: can it grow enough to support such a huge P/E metric in an increasingly fierce market where competitor Viadeo, with already more than 50 million members worldwide, is already stronger than LinkedIn in emerging economies?
The recent 10.6% price increased was caused because LinkedIn Corp (NYSE:LNKD) managed to beat the Street EPS consensus by $0.03 earnings $0.07 per share, causing the stock to reach a new all-time high, making the stock even more expensive. Truth be told, the second-quarter earnings were quite positive, showing a 33% increase in earnings due to record membership rolls. What does not seem rational is the market’s overreaction to a stock that was already overvalued.
In early May, LinkedIn Corp (NYSE:LNKD) gave a poor weak growth forecast, causing shares to fall more than 10% in after-hours trading despite posting relatively robust first-quarter results. The weak forecast given in the first quarter caused most sell-side analysts to reconsider their price targets. The upside was that by guiding weak guidance, LinkedIn actually lowered the high expectations of the Street and prepared the road for beating the new estimates in the second quarter. And that’s actually what happened last week!
But now expectations are high again. The third quarter is going to be even more difficult to deal with, and considering the astronomical P/E ratio, it’s wise to expect a price correction after the next earnings are released in three months.
LinkedIn: The place where you put your CV online or the hub for all professional activity carried online?
The current market valuation is not sustainable simply because, to support it, we would need to assume an extremely high annual growth rate of users, in the 30%-range, for the next five years. In other words, this implies transforming LinkedIn from its current state into a massive global hub for all kinds of professional activities from software engineering to medicine.
I doubt that will materialize, as users seem to see LinkedIn Corp (NYSE:LNKD) as the place where they can put their CV online, but not where most of their professional activity is being done. Instead, professionals tend to group themselves into smaller, more elitist platforms. Software engineers use Github.com, Financial professionals register at SumZero, Academia.edu is for researchers, RePEC for economists, DeviantArt and Basecamp for designers, Proformative for accounting, Doximity for medicine and so on. Apart from the groups feature, LinkedIn is doing nothing to stop this trend.
Notice also that Morningstar price estimate for LinkedIn is $135 per share, well below its current $235 market price. RBC Capital has a $190 price target on the stock, while UBS AG has a “neutral” rating and $230 price target.
Finally, for those who still have doubts whether LinkedIn is overvalued or is a growth stock, the following graphic using data from the latest earnings release is worth checking. LinkedIn is increasing revenue, but the growth rate of revenue is decreasing, showing that LinkedIn has already graduated from its “high growth phase” and it’s becoming a mature IT firm.
Better alternatives?
Although LinkedIn is probably the best monetized social network at the moment (with revenue coming from advertisement, premium subscriptions and Human Resources solutions), I think that the current price estimate is far above the true value that fundamentals suggest. Add to this increasing competition from Viadeo and other smaller networks, and you have plenty of risks to stay on the sidelines.
Social networks are a relatively new industry, and investors need to learn more about how to value them. In the meantime, I expect PE ratios to be substantially higher than the S&P 500 average. But a 600+ PE ratio is definitely not inside my tolerance margin.
There are some interesting alternatives to LinkedIn Corp (NYSE:LNKD) worth exploring. My favorite picks include Facebook Inc (NASDAQ:FB) and Renren Inc (NYSE:RENN).
Facebook’s high user engagement, especially when using the mobile app, is a plus. Also, Facebook Inc (NASDAQ:FB) is still experimenting with various monetization approaches. This suggests that monetization can get even better, as Facebook Inc (NASDAQ:FB) ads are still rare. The high exposure to mobile (41% of total revenues came from the mobile business) makes this stock worth watching.
Renren Inc (NYSE:RENN), on the other hand, has two merits. First, it owns the biggest social network in China. Most Renren users are young or students, but as they enter the labor force and their income starts increasing, Renren’s user base will become richer. The second merit is that Renren has a diversified portfolio, owning a game platform, a wedding site and even a Groupon-like app, Nuomi.com, which is growing fast. At the moment Renren is not in the profit zone, but I expect it to break the buck by the beginning of next fiscal year. The time to buy, though, is now.
The article Why the Most Overvalued Social Network Stock Keeps Growing originally appeared on Fool.com and is written by Adrian Campos.
Adrian Campos has no position in any stocks mentioned. The Motley Fool recommends LinkedIn. The Motley Fool owns shares of LinkedIn. Adrian is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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