Disruptive businesses like LinkedIn (LNKD), Trulia (TRLA), and Amazon (AMZN) often trade at higher valuations than do older firms. Do they trade at attractive valuations? If they are more expensive than older firms, what premiums should investors consider reasonable? We will investigate more traditional stocks and their disruptive counterparts to determine if higher valuations can be justified for innovative companies.
At a price of roughly $119 per share LinkedIn recently traded at an astronomical 990 price-to-earnings multiple. Equity in this company is rich on a price-to-sales basis since shares trade at a 17.35 multiple, remarkably higher than the 1.29 the S&P 500 average.
Why is it trading so high? A group of analysts working for Jefferies published a research report that predicted LinkedIn's stock price would rise to over $140 within a year and that revenue will more than triple during the next few years, rising from the predicted $522 million in 2012 to almost $2 billion in 2014.
The analysts believe that LinkedIn's earnings will be driven by more and more people posting their resumes to the website. Currently, over 170 million members have created profiles on LinkedIn, with almost 100 million members joining in the past two years. Economically, LinkedIn is a recruiting industry business. It makes a profit by charging members fees for certain areas of its databases and for the use of tools that will help employers find the best candidates for a specific job opening. It can be thought of as a substitute for traditional staffing firms.
Staffing firms would also benefit from declining unemployment. ManpowerGroup (MAN) stock is reasonably priced at $37 per share. When compared to the 1.29 price-to-sales ratio of the S&P 500, the 0.13 ratio of this stock is very attractive and less than one percent of LinkedIn's price-to-sales ratio. MAN shares are trading at a fair 13.35 price-to-earnings ratio, which is a downright steal when compared to the 990 LinkedIn price multiple. The price-to-book multiple of this stock is 1.16, cheaper than the 2.05 S&P 500 average. Clearly the valuations of MAN shares are much, much more attractive than those of LNKD shares.
Trulia's Curb Appeal
Trulia is an operator of a popular real estate website which lists residential properties and recently raised over $100 million in a public offering. The IPO valued total debt and equity of Trulia over $400 million, which is about 8.8-times last year's sales of over $50 million. According to the filing, the proceeds from the IPO are slated to be used to boost its working capital.
Trulia has been gaining more users, and generating income by selling subscriptions to smartphone and tablet apps. The company has stated that its website and mobile applications are currently being used by over 20 million visitors per month.
The success of the IPO has been attributed to how the U.S. housing market is showing broad evidence of a recovery. Thus, investors are thinking of Trulia as though it is in the residential real estate business.
As a real estate business, Trulia stock's $22 per share price is far too high. Equity in this company is rich on a price-to-sales basis since shares trade at a 11.32 multiple, higher than the 1.29 the S&P 500 average. TRLA shares are trading at an incalculable price-to-earnings ratio (there was net loss for the last twelve months).
In contrast, more reasonable valuation can be found in homebuilder Lennar (LEN) at about $37 per share. The firm's 1.88 price-to-sales ratio is in line with today's prevailing market multiples and about a sixth the valuation multiple of Trulia. LEN shares are trading at a fair 13.85 price-to-earnings ratio and a 2.19 price-to-book ratio, both of which are near the 2.05 S&P 500 average.
Retail Valuation Sticker Shock
Like these other disruptive business models, online retailing (or etailing) is a serious threat for brick and mortar retailers. Unfortunately, the valuation the web's largest etailing firm is far too high for disciplined investors.
For example, Amazon.com stock is too expensive at a price of roughly $251, a price level which seems impossible to justify. AMZN shares are trading at an indefensibly high 306 price-to-earnings ratio. This isn't the result of a one-time writedown: overzealous investors have consistently bid up the p/e ratio of this stock into triple digits. Investors should stay away from these share prices which are apparently divorced from economic reality.
As a contrast, consider Wal-Mart Stores (WMT) stock trading around $74 per share. When compared to the 1.29 price-to-sales ratio of the S&P 500, the 0.54 ratio of this stock is very attractive. WMT shares are trading at a fair 15.61 price-to-earnings ratio, in line with the S&P 500 average and a twentieth the valuation of Amazon. Let me repeat that: on the basis of earnings Amazon is twenty times as expensive as Wal-Mart.
Clicks vs. Bricks
Investors should consider traditional, brick and mortar investments as ways to play industries as alternatives to sexier tech companies. This is not a question of the risk involved in new ventures or new business models (though Trulia was sued by Zillow (Z) over patent infringement on a software program used for home valuation). Instead, this is really a question of valuation. Unfortunately, today's share prices for Trulia, Amazon, and LinkedIn are just too high. These are interesting businesses, but their many-fold valuation premiums over incumbent firms are indefensible.
Please read the article disclaimer.