The Smart Way to Invest in LinkedIn Corp (LNKD)

LinkedIn is much more than a social and professional network, the company is a disruptive innovator in the global human resources industry, it has a rock solid business model and outstanding long term growth prospects. Valuation may be hard to grasp, but that shouldn´t stop intelligent investors from making money in LinkedIn Corp (NYSE:LNKD) over the coming years.

LinkedIn is usually associated with Facebook Inc (NASDAQ:FB), since both companies can be put under the “social networks” category, and some people tend to think of LinkedIn Corp (NYSE:LNKD) as the professional oriented version of Facebook Inc (NASDAQ:FB). When it comes to business models and competitive strengths, however, there are big differences to consider.

While Facebook makes most of its money from advertising, LinkedIn makes only 23% of revenues from that business. The big cash cow when it comes to LinkedIn is talent solutions for employers, which provided 57% of revenue in the last quarter, with the remaining 20% coming from premium subscriptions.

Online advertising is a growing market, but Facebook Inc (NASDAQ:FB) needs to compete against an undisputed industry leader like Google Inc (NASDAQ:GOOG) in addition to smaller players. Google Inc (NASDAQ:GOOG)‘s search product is almost ideal when it comes to online advertising: when someone in a certain area is searching for “Mexican restaurant,” for example, the owner of a nearby Mexican place has some big incentives to pay up in order to come out better positioned than its competitors.

Information and context are crucial assets in online advertising, and Google Inc (NASDAQ:GOOG) has access to enormous amounts of data regarding users of its multiple services. Besides, traffic is shifting towards mobile, and Google is in a position of remarkable strength in that industry since it owns not only the leading mobile operating system on a global scale, Android, but also applications and services like Gmail, YouTube, Search and Maps, which are tremendously popular among different platforms.

LinkedIn Corp (NYSE:LNKD), on the other hand, is the top dog in online recruiting, and its customer base of more than 225 million users provides a self sustaining competitive advantage for the company via the network effect. The bigger LinkedIn gets, the more valuable the service becomes for both hiring companies and professionals, and this at the same time attracts more users from both sides.

LinkedIn Corp (NYSE:LNKD) is delivering explosive growth rates; revenues have increased at an average compounded growth rate of more than 97% annually over the last five years. Importantly, the talent solutions segment has been gaining participation versus advertising – marketing solutions – and this is a big positive in terms of business model quality.

Source: LinkedIn earnings presentation

The company still has a lot of room for growth; management estimates that its addressable market is worth around $27 billion, so we may have only seen the tip of the iceberg at this stage. When it comes to international expansion, the company is now present in nearly 200 countries, but it has barely scratched the surface in terms of monetizing its user base in high growth emerging markets.

LinkedIn Corp (NYSE:LNKD) is a high-quality business with huge opportunities for growth over the long term, and the company could certainly be worth multiple times its current market value in five or ten years. On the other hand, valuation is nothing short of stratospheric, and this means that investors could be up for some considerable volatility if there is any kind of slowdown in growth or some other disappointment.

When comparing valuation ratios like forward price to earnings or price to sales for LinkedIn versus Facebook and Google, the company is looking much more expensive. LinkedIn deserves a premium for its outstanding growth potential, but it also makes the company quite vulnerable to bad news. A disappointing earnings report or anything like that could generate a big sell-off in such an expensive growth stock.

On the other hand, staying away from the company only because it’s trading at high valuation multiples is not the smart thing to do. Many of the greatest growth stories of our times have traded at sky high valuations for years, or even decades, and they still have delivered substantial returns for investors who had the vision to invest in these names at an early stage.

Starting with a small initial position is probably the best way to play LinkedIn. If the stock then suffers any material setback, investors would get a chance to add to the position at a more convenient price. As long as the fundamental case for LinkedIn remains intact, pullbacks should be considered buying opportunities.

The problem with this approach is that if LinkedIn Corp (NYSE:LNKD) continues firing on all cylinders it may never offer a chance to buy more at lower prices; in that case investors will probably regret having a relatively small position in the company. Still, worse things can happen than seeing a stock take off and never come down after your initial purchase.

Bottom Line

LinkedIn is a disruptive company with self sustaining competitive advantages and superior potential for growth. The biggest drawback is valuation, but investors shouldn´t let that scare them away from this opportunity. Following a patient strategy by starting with a small position and buying on pullbacks could be a sensitive approach to investing in LinkedIn.