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HistoricalPEGuy (63.30)

LNKD: A Great Model for Investing in Growth Stocks

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February 12, 2013 – Comments (9) | RELATED TICKERS: LNKD

Given the 1-star rating that LNKD has on CAPS, a lot of players took a big loss on Friday.  How could so many people be wrong?

Easy - they were fooled (pun intended) by the valuation of the stock.  Sadly, many investors just look at P/E - as if its the end-all, be-all of all metrics (and I understand the irony of my handle).  That said, some investors just simply thought that LinkedIn couldn't keep the revenue upside, especially for paid-for services.  In that case, they just bet on the wrong side of the coin.

For the investors that rated LinkedIn "overvalued", here is what you missed.  The "P" in the P/E is very high, so you really need to focus your attention on the "E".

So now take a look at how revenues convert to earnings -- the Balance Sheet.  What if LNKD stopped growing R&D and SG&A?  I personally believe that their biggest sales force is word of mouth and HR recruiters needing to find talent.  With that hypothesis -- they will continue to grow at very high rates EVEN IF THEY SHUT OFF SPENDING.  The result is a P/E that plummets faster than a lead weight in water.  Do the math...  Chopping their growth rate to 20% with no change in spending gets them to a P/E of 30 within just a handful of years.

A big kudos to LNKD for investing hard now and fueling their growth.  If you consider the fact that B2B spend is 50% of the economy vs. 50% B2C, you should be using FB as benchmark of where LNKD can potentially go - not to mention the overstated "barrier to entry" argument that FB has continued to expose as down right silly.

That's why I own LNKD and will continue to buy.

-- HPEGuy 

 

 

 

 

 

 

 

9 Comments – Post Your Own

#1) On February 12, 2013 at 10:40 AM, Mega (99.96) wrote:

Nothing really changed on Friday - nobody was proved wrong or took a loss (unless they decided to sell). Mr. Market is manic depressive and I'm pretty confident he will offer LNKD shares lower than $155 over the next few years.

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#2) On February 12, 2013 at 10:42 AM, Mega (99.96) wrote:

"decided to sell" -> "decided to cover"

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#3) On February 12, 2013 at 11:35 AM, chk999 (99.97) wrote:

LinkedIn will be a monster growth story.

Until it isn't.

Plan your exit accordingly. 

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#4) On February 13, 2013 at 12:43 AM, HistoricalPEGuy (63.30) wrote:

MegaShort - I totally disagree.  People throw the term "overvalued" around way too much.  My point is not just about their great growth, but the incredible spending spree they are on to fuel that growth.  They could fire half of their staff tomorrow, turn in a P/E of 20 and still grow (more modestly).  That point is completely missed by the investing community.  If you honestly think they can't grow their business, then that's a reason to bet against them.  But if someone says they are "overvalued" but also recognize the huge growth potential, they don't get it.

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#5) On February 13, 2013 at 1:43 AM, Valyooo (99.55) wrote:

Megashort is a prime example of somebody who did not understand the points you made.

 

I am sure a lot of margin calls were generated...ever try shorting the tech bubble?  I bet it wasn't fun.

 

I find that people who overuse investment sayings have nothing original of their own to say.

 

+1 good blog.  I personally would not buy LNKD, but would not come close to shorting it 

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#6) On February 13, 2013 at 10:40 AM, Mega (99.96) wrote:

Just because I didn't respond to everything he said, does not mean I don't understand it. I disagree completely that you can subtract SG&A and pretend that number is meaningful.

Ever try buying the late stages of the tech bubble? Not much fun either.

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#7) On February 13, 2013 at 11:38 AM, Valyooo (99.55) wrote:

When you short a stock, and it goes up 22% in a day, yeah, you were proven wrong.  Even if you were long term right, you were still wrong.  If I said "apple will go out of business, I am going to short" am I right if it takes 675 years?

 

I manage other peoples money....drawdown of 22% does not look good in VaR statistics. 

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#8) On February 13, 2013 at 11:42 AM, Mega (99.96) wrote:

That's part of the beauty of the market. People have different risk tolerances and time horizons.

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#9) On February 18, 2013 at 12:51 AM, HistoricalPEGuy (63.30) wrote:

It's not really about subtracting SG&A or R&D, its about slowing that spending down and asking if growth can continue.  Understanding whether a high growth stock is "overvalued" is no easy task - but this simple exercise can put hard math behind the question.

For LNKD, after doing the math, I would say its at "fair value"
 and nowhere close to being "overvalued".

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