1 Internet Company to Watch and 3 to Ignore
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Developing an economic moat is a critical part of any business. In the online world this need is magnified due to the low barriers of entry. In the absence of high fixed costs, strong brand development can be one of the best tools to grow a defensible position. Many internet stocks have quickly growing revenues, but a fundamental analysis of their business shows weakness. Bankrate (NYSE: RATE) is a stock with a well-known brand and encouraging macro-fundamentals that is worth checking out.
RATE Revenue Quarterly data by YCharts
Bankrate operates in the world of online consumer finance. Their various brands offer credit cards, mortgage, and insurance leads. On average Google receives 135,000 searches every month for the exact word "Bankrate." This type of search is called branded search and is a sign that consumers know the brand and take action to engage with the company.
Online portals like Google, Bing, and Yahoo are long-term threats to Bankrate because they can redirect consumers to their own products while hiding Bankrate's offerings. The growth of mobile and smart phones is a very encouraging trend for Bankrate. With their own branded apps they are able to connect to consumers without the consumer ever having to use an online portal.
2013 earnings are expected to come in around $.61 per share. With a current stock price around $12 the company is trading at a forward P/E around 19.7. Their ROI of 4.2% and ROA of 3.6% show that they do not use their resources as effectively as Google, but there is hope for future improvement. American households continue to pay off debt and the stability in the housing market will improve consumer confidence. With better balance sheets and falling unemployment more people will be able and willing to buy financial products and Bankrate will profit.
Companies with a Medium Moat
Zillow (NASDAQ: Z) works in the real estate market. They provide services to house buyers and real estate agents to help speed up and simplify the selling process. Their listings have become a strong tool for both sellers and buyers and Google records an average of 2.7 million searches for "Zillow" every month. A simple script for an online real estate site is easy to find, but a site with millions of branded searches and many listings shows the development of a moat.
The housing market is starting to come back and Zillow's numbers reflect this change. They recorded an 80% increase in premier agent subscribers between September 2012 and a year before. In the first three quarters of 2012, display revenue was only 26% of earnings while marketplace revenue came in at 74%. The fact that the majority of revenue came from the marketplace is very encouraging because the marketplace is Zillow's unique offering. Display ads are a dime a dozen.
Sadly, the company is trading at very rich valuations. 2013 EPS are expected to come in around $.29 and the current share price around $36 gives the firm a forward P/E ratio of 124. Zillow is a good company to watch, but currently valuations are too high for comfort.
LinkedIn (NYSE: LNKD) is the well-known social network for professionals. Google's struggles with Google+ show that developing a social network is not an easy feat. LinkedIn has managed to grow their user base to 200 million users. This user base gives LinkedIn that all important moat. Even though Facebook has a larger user base, LinkedIn's professional audience is inherently smaller.
Still, valuations have gotten out of hand. 2014 EPS estimates come in at $1.11. Currently shares trade around $150, which gives the company a forward P/E ratio of 135. Year-over-year revenue growth has already started to slow down. Even with a gross margin of 86.4% LinkedIn's ROI 2.1% shows that some degree of caution is necessary. Bulls cite the need to invest for future growth as justification for low ROI, but the amount of future growth is certain. Until LinkedIn trades at lower valuations it is best left for another day.
A Company with a Very Small Moat and Rather Unclear Strategy
Groupon (NASDAQ: GRPN) is an interesting firm that has had a quite visible life lately. Accusations of ripping off merchants and their very creative accounting measures make for good news stories. Their model of selling deals to consumers through an email list is not very difficult to replicate. The entry of well-funded competitors like Living Social shows the danger of operating without a strong moat.
The company's strategy is rather unclear and they recently entered the payment space in addition to their journey into ecommerce. Diversifying out of a daily deals business model is encouraging, but it is still unclear if Groupon will be able to compete successfully.
Over the past year the growth in number of active customers has decreased. They have no debt and an EBIT margin of 6.2%. Even with a gross margin of 77.9%, Groupon faces massive costs and a headcount above 10,000 that drag down earnings. Paying an army of salesmen and saleswomen is not cheap. In addition to these issues, the company is not cheap and trades at a price to sales ratio of 1.58. Groupon is best ignored until their strategy and earnings come back.
Conclusion
Creating a unique and defensible position is critical for the success of any business. Bankrate has already proved its ability to grow the brand and make itself known to consumers. The decreasing unemployment rate and gradual economic recovery will help to boost demand for its financial products. Additionally, it is not extremely overpriced and can be picked up for less than 20 times expected 2013 earnings.
MrCanadian1 has no position in any stocks mentioned. The Motley Fool recommends LinkedIn and Zillow. The Motley Fool owns shares of LinkedIn and Zillow. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!
