After reaching an all-time high of $75.37, Yelp (NYSE:YELP) experienced a correction where the share price fell by 23% to $58.15, but since then, the share price bounced up to low $60s. Now it's still down 16% from its October high and the company is still madly overvalued. Analysts continue to pump Yelp based on empty hype and investors continue to buy the shares even though there is no justification for it. Yelp is one of the biggest reminders of 1999's dotcom bubble and those things never end well.
Analysts currently have a price target of $70 on Yelp and some analysts' targets go as high as $85. Of the 26 analysts covering the stock, 13 rate it as either "strong buy" or "buy" and 13 rate it as "hold" with no "sell ratings" despite its ridiculous valuation.
Here is the funny thing though, even those analysts who give Yelp sky-high targets don't believe in the company's success anytime soon. These same analysts expect Yelp to post a loss of 14 cents per share this year, followed by a net profit of 19 cents per share in 2014. The analyst estimates for the fiscal year 2014 range from 2 cents of profit to 44 cents of profit. In fact, just 3 months ago, the average analyst estimate for 2014 was actually 24 cents as opposed to the 19 cents today. The analysts have cut down their expectations considerably in the last few months from Yelp's earnings estimates, yet they didn't cut their price targets at all. Now, keep in mind that Yelp has never posted a profit in its history and it is doubtful whether the company will ever become profitable. At the average analyst estimate, Yelp is currently trading for 336 times its 2014 earnings, and even by the most optimistic estimate, the company is trading for 145 times its 2014 earnings.
The story doesn't end here either. Even these analysts who believe so much in Yelp see the company's growth rate slowing down considerably in the next few years. For example, in 2010, Yelp generated $47.73 million in revenues, up 85% from 2009's $25.81. In the following year, the company increased its revenues to $83.28 million, up 74% from the previous year. The growth rate had already slowed down from 85% to 74%. In 2012, Yelp's growth rate slowed further to 65% as it increased its revenues from $83.28 million to $136.50 million. According to the same analysts who continue to give Yelp sky-high valuations, Yelp is looking at a growth rate of 57% this year and an average of 40% in the next 5 years.
So, the analysts see Yelp's growth slowing down for the foreseeable future, they don't think it will be that profitable anytime soon, yet, they continue to give Yelp ridiculously high price targets. Why won't an analyst drop his target price estimate when he drops his future earnings estimate for the company? This makes no sense and shows me that the analysts aren't basing their earnings estimates on any fundamentals, but more on empty hype.
Now, I can hear you thinking that Yelp will still grow at a relatively fast rate (40% in revenues until that gets downgraded too) so it deserves a higher P/E than the market average. I agree that we can't give Yelp a P/E value of 10-15 when it continues to grow in double digits. On the other hand, the company isn't growing fast enough to warrant a forward P/E of 300+ either.
According to analysts, Yelp is expected to generate $346 million in revenues in 2014 and grow its revenues by an average of 40% for the next 5 years as I've mentioned above. This gives us a revenue estimate of $485 million in 2015, $679 million in 2016, $951 million in 2017, $1.33 billion in 2018 and $1.86 billion in 2019. The analysts also expect Yelp to grow its earnings by 40% even though the company has never been profitable in its history and has always been enjoying negative margins. So, if Yelp can earn 19 cents per share and grow it at a rate of 40% each year for the next 5 years, it will look at net profit of 27 cents in 2015, 37 cents in 2016, 52 cents in 2017, 73 cents in 2018 and $1.02 in 2019. So, even after 5 years of very optimistic growth estimates which may or may not come true, Yelp will be looking at a forward price to revenue ratio of 2.24 and a forward price to earnings ratio of 60. This also assumes that Yelp's price will stay flat for the next 5 years though. When investors put their money in companies, they expect their value to appreciate because that's the whole point of investing. If we assume an annual discount rate of 15% for Yelp (which is pretty conservative considering how volatile this stock is), the company's price to revenue ratio increases to 4.50 and its price to earnings ratio increases to 121 for 2019. This is ridiculously high.
The calculation above doesn't even keep dilutions into account. For Yelp, dilution has always been part of equation even though most analysts choose to ignore it. Just four quarters ago, Yelp had 62.22 million outstanding shares; today the company has 69.70 million outstanding shares. Just two months ago, Yelp issued 3.7 million shares to raise additional capital (because it's not profitable and selling shares is the only way for Yelp to generate cash flow at the moment). Furthermore, the company keeps issuing new shares to pay its employees so it adds about a million shares per year to its outstanding share number for this purpose alone.
For example, the company's CEO Jeremy Stoppelman holds hardly any shares of the company because he keeps selling shares periodically. Every time he's awarded new shares, he gets rid of them quickly. You can see his recent transactions in this link. While I don't always believe that insider sales constitute a problem, this may become a problem with Yelp's case. They say that an insider can sell shares for any reason, which is true. For many insiders, selling shares is a way to supplement their income and pay for their living expenses. This is perfectly fine and I am not going to look at the reasons why Yelp insiders keep dumping shares in the market. What I am more concerned about is the fact that each insider sale will increase dilution and if we go at this rate, dilution will eat much of Yelp's future growth even in the absence of future secondary offerings.
I just don't know how analysts come to price targets like 70% when even their optimist estimates see the company's growth slowing down and there is too much uncertainty about the company's future profitability. Yelp isn't profitable, it is not growing fast enough to justify its high valuation, insiders keep selling, dilution keeps increasing, and once someone starts discounting future share appreciation, it is so easy to see that Yelp is overvalued by at least 50% even after its correction. Does that mean Yelp will fall by 50%? It probably won't happen soon because the market dynamics (fueled by the Fed's printing activities) will continue to support this bubble for a while. They say that the market can remain irrational longer than many of us can remain solvent. This is why I am long both puts and calls of the company as an insurance policy, just in case things don't go my way.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I'm long YELP's calls and puts at the same time as an insurance policy.