Poll: Is LinkedIn a Huge Bubble Waiting to Burst?
Professional online network, LinkedIn Corp (NYSE: LNKD), went public nearly seven months ago in an extremely successful initial public offering that was priced at $45 per share and opened for trading over 80 percent higher at $83. For older traders, this brought back memories of the good ol' days of the late ‘90s when the tech IPOs like this were nearly an everyday occurrence and millionaires were made overnight.
Since going public, the stock has been highly volatile, ranging from $122 per share to all-time lows of $56, which could have been due to the difficulty to determine the appropriate valuation for the company. The current P/E ratio of 1,400 makes the stock extremely expensive at the current price levels. For comparison, another online job search company, Monster Worldwide (NYSE: MWW) has a P/E ratio of 22.4.
Also, the company's 17x PEG ratio, which takes into account the growth rate, is incredibly high compared to the industry average of 1.58. To put this in perspective, another recent high-flyer, Chipotle Mexican Grill (NYSE: CMG), has a PEG ratio of 2.23. Essentially, this means that the investors have to pay big bucks to get their share of LinkedIn's future earnings and potential earnings growth.
Although LinkedIn's earnings multiples are exceptionally high, its most recent quarter's revenue growth of 125% is nearly five times higher than the industry average. This makes the company's trailing price/sales ratio of 15.95 very cheap compared to the industry average of 172. In November, the company announced a follow-on public offering of 8.75 million shares that was priced at $71 per share, which was dilutive to the shareholders.
According to the company, it currently has approximately 135 million users worldwide. However, unlike many other social networks, advertising does not comprise the majority of LinkedIn's total revenue. More than 2 million companies have LinkedIn pages now and in the third quarter of 2011, hiring solutions revenue made up 51 percent of the total sales. The diversified revenue sources may help the company maintain its strong sales growth also in the future.
The key question that the traders should ask is whether the company can transform its rapid top line growth into earnings growth as well. This would justify the current high valuation, $65 share price, and potentially even boost the stock value. Otherwise, the astronomical P/E ratio may be an indicator that there is a bubble forming in LinkedIn.
Traders who believe that LinkedIn's fast revenue growth will eventually make the company highly profitable might want to go long LinkedIn. On the other hand, the traders who want to get exposure to the entire sector may want to go long Global X Social Media Index Fund ETF (NASDAQ: SOCL).
Traders who believe that what goes up must come down (unless there the fundamentals are supporting it) may want to short LinkedIn. Also, the traders who think that the high valuations are a sign of a bubble forming in the social media sector, may want to invest in more traditional companies, such as Caterpillar (NYSE: CAT) or IBM (NYSE: IBM).
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