What To Do After Groupon's Missed Earnings

Feb. 9.12 | About: Groupon, Inc. (GRPN)

Groupon (NASDAQ:GRPN), who was expected to post their first quarterly profit, failed to get into the black as the "fastest growing company ever" reporting a non-GAAP loss per share of 2 cents and a net loss per share attributed to common shareholders of 8 cents. Revenue, however, beat estimates as the company reported over $1.6 billion in revenue in 2011.

The announcement made Groupon's shares drop by over 15 percent at some points in after hours trading and disappointed investors. In this article, I express my concerns with Groupon's earnings report along with some investment advice going into the future.

Groupon's stock price, unfortunately, is in almost no way controlled by the free market economy that we're all so proud of. A huge chunk of Groupon's stock is owned by a small group of shareholders and still has a very small float as only about 5 percent of outstanding shares were floated in its IPO. Small floats can substantially distort value. For example, if I started my own company and sold 0.01 percent of it to my parents or a close friend for $100, I would technically be a millionaire. This is an extreme picture of what Groupon did, but it should give you a better idea of how the company's stock price doesn't necessarily reflect its true value.

Relatively small selloffs and buy ups of the stock can affect share price substantially. In early trading on February 7th, a high volume selloff of Groupon (along with some other tech darlings) brought shares down over 5 percent in a matter of minutes and then shares rebounded quickly. Before the close of trading on February 8th, right before its earnings announcement, there was a flash buy-up of shares that raised the stock price by 5 percent in a matter of minutes. Flash crashes and spikes happen frequently in stock trading, but very rarely does this abnormal trading activity happen 2 to 3 times per week.

Groupon's revenue beat, in my opinion, actually hurt the company since much of their value proposition is based on its operating leverage. A relatively small increase in revenue growth is supposed to trigger a huge increase in earnings per share. Groupon's expected earnings are essentially an application of a model that predicts what the company's earnings will be based on its revenue, which is the more predictable metric. The fact that Groupon beat revenue but still missed badly in earnings suggests that the implied model was wrong and earnings won't jump as quickly as expected. This can substantially hurt the stock price going forward, especially if Groupon misses revenue estimates in the near future.

Here are my current suggestions for how to trade off of Groupon's earnings announcement:

1. Go long volatility on Groupon. Despite being overvalued, the stock will probably trade anywhere between $15 and $25 over the next few days. Going long options can put you in this position. If you're a conservative investor, I suggest avoiding GRPN until at least the next earnings announcement.

2. Go long Google (NASDAQ:GOOG) and/or Amazon (NASDAQ:AMZN). Both companies have a high stake in the daily deals business. Google has Google Offers and Amazon owns a big piece of Living Social. I believe Groupon's revenue beat suggest that daily deals is beating expectations of becoming an acceptable way for consumers to buy. I know both companies are huge and their daily deals businesses are only a very small piece of the pie, but Google and Amazon know how to generate long term earnings and take over new industries that they enter. I personally prefer Google because its shares trade at a much lower multiple, but both stocks should grow in the coming months.

Groupon is still a young company and nobody can guarantee whether or not it will grow to meet investors' long term expectations. However, its failure to post its first profitable quarter will turn away a lot of investors and Groupon's trading activity right now is based more on group think than data. By trading Groupon with caution and keeping an eye on the developing daily deals industry, the smart money will end up making a pretty penny from dabbling in daily deals.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.