Why was analyst guidance about Yelp’s strong outlook so wrong?

Market Realist

Must-know: Understanding Yelp's enormous opportunity (Part 2 of 3)

(Continued from Part 1)

New business discovery platforms

Yelp (YELP)—along with peers like Groupon (GRPN), OpenTable (OPEN), and Foursquare—have revolutionized the way local businesses make themselves known to potential customers. These disruptive companies harnessed the power of social media to create new platforms for local businesses to grow revenue by connecting with more customers. Yelp has had particular success in building out its platform, as the stock has returned roughly 217% over one year. Yelp and Groupon are members of the Global X Social Media Index ETF (SOCL), which provides exposure to an index of social media stocks.

Analyst concerns

As we discussed in greater detail in Part 1 of this series, Yelp has experienced rapid growth since the company’s IPO in March 2012. At that time, Yelp had built a database of nearly 28 million user reviews. Today, that number stands close to 50 million. These results have raised hopes of greater profitability in the future, leading to the boom in the stock.

However, for the period following the IPO, the stock languished around $20 per share. Investors were primarily concerned with the company’s lack of profitability and encouraged management to cut spending as a way to increase earnings and profit margins. Despite this pressure, management remained committed to its strategy of sacrificing current profits in order to invest in the mobile platform, its advertising sales team, and geographical expansion. On a recent earnings call, the company’s CFO, Robert Krolik, said, “We think of smart spending on new markets as an investment until we generate revenue.”

The chart above depicts the company’s EBITDA profit margin. Earnings before interest, taxes, depreciation, and amortization (or EBITDA) is a useful measure of profitability in order to evaluate a company, as it strips out issues of capital structure and non-cash expenses. The chart shows that analysts were overly concerned with profitability in the short term, while management’s strategy of prioritizing revenue growth as a way to eventually grow profits now appears to be on a successful path. Yelp is still in the early stages of its lifecycle—as user engagement and monetization efforts continue to take hold, greater profitability will likely follow.

Continue to Part 3

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