Is LinkedIn a Worthy Candidate for Your Portfolio?

LinkedIn (NASDAQ:LNKD) has quickly become a Wall Street darling since its IPO back in 2011. The stock has surged around 70 percent since the beginning of the year. Investors are bullish on LinkedIn because it has succeeded in an area where Facebook (NASDAQ:FB) has not: monetizing its user base. Bulls justify the company’s high stock price with its double-digit growth rate and unique business model; however, as the industry changes and competition increases in the future, can LinkedIn continue to enjoy its dominance? Let’s use our CHEAT SHEET investing framework to decide whether LinkedIn is an OUTPERFORM, WAIT AND SEE, or STAY AWAY.

C = Catalysts for the Stock’s Movement

Despite exceeding analysts’ estimates in its first quarter earnings announcement, LinkedIn was dinged because of its reduced earnings guidance for the second quarter. The star performer was its talent solutions segment—the core of LinkedIn’s business operations—which connects recruiters with users. This division generated 57 percent of total revenues and grew 80 percent from the previous year’s quarter. LinkedIn’s marketing solutions (read: advertising) division grew a solid 23 percent. While this growth is not as impressive as growth in its talent solutions unit, it is still solid, especially amidst fears that the company would have trouble generating ad revenue from its growing mobile user base. Lastly, LinkedIn generated 20 percent of its revenue through its premium subscriber base—while most users spend nothing to use the site, others pay a monthly fee to unlock exclusive features. Revenues from premium subscriptions rose 73 percent from the previous year’s quarter.

The stock fell about 10 percent the day of this earnings announcement, not because it underperformed in the first quarter, but because it set relatively low earnings guidance for its second quarter. CEO Jeff Weiner and the rest of LinkedIn’s management team have been notably conservative in their past earnings projections, but shareholders were clearly spooked about the slow growth projections. The reason they are buying LinkedIn at such a high multiple, after all, is because of the high and sustainable earnings growth prospects. With no significant catalysts in the near term, barring the second quarter earnings announcement sometime in early August, the share price should actually trend downward on expectations of slower growth.

E = Earnings and Revenues Are Increasing Year-over-Year

In terms of earnings and revenue growth, LinkedIn has performed incredibly well since its IPO in 2011. Excluding negative EPS growth in the second quarter of 2012, LinkedIn has been on a tear, shattering analysts’ expectations in most quarters. The strong growth evident in the table below is why investors are willing to buy LinkedIn at a trailing price to earnings multiple of more than 700; however, exuberance for the stock will surely taper off as growth slows. Still, when looking at these numbers, its hard to imagine LinkedIn posting negative quarterly earnings growth in either the short- or medium-term.

2013 Q1 2012 Q4 2012 Q3 2012 Q2 2012 Q1
Qtrly. EPS $0.20 $0.1008 $0.02 $0.03 $0.04
EPS Growth YoY 400% 68% 200% -25% N/A
Qtrly. Revenue $324.70M $303.62M $252.03M $228.21M $188.46M
Rev. Growth YoY 72.3% 80.73% 80.70% 88.54% 100.6%

T = Technicals Are Strong

LinkedIn is currently trading at around $193.11, well above both its 200-day moving average of $160.43 and its 50-day moving average of $175.27. From the chart, it is clear that LinkedIn has experienced a strong uptrend in the past year, let alone since its 2011 IPO. The stock would have to gain around 6.5 percent to get back to its previous 52-week high of $202.91 it reached back in May. With contracted guidance for the second quarter and no significant near-term catalysts, it is unlikely the stock will break through this resistance level until second quarter earnings are announced.

Conclusion

What attracted investors to LinkedIn in the first place is its difficult-to-replicate business model. Because LinkedIn is the first and the biggest professional social network, there is some degree of permanence attached to its user base; i.e. users will find it hard to switch to a competing service because they will lose their connections and professional identity they built through LinkedIn. Stable revenues and high switching costs will ensure LinkedIn’s profitability for many quarters to come; however, at a trailing price to earnings multiple of 746, the stock is trading at too high of a price to warrant a purchase at this point in time. The share price will most likely contract to a more reasonable once investor exuberance subsides; thus, there will be a more attractive level at which to buy the stock. For now, LinkedIn is a WAIT AND SEE.

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