When Priced For Perfection, You Need Perfection

Brian is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Shares of social media company Yelp (NYSE: YELP) fell 10% after announcing quarterly results. The company’s quarter was very strong, a solid beat compared to expectations. However, the stock was priced at perfection, and perfection was not achieved.

Quarterly Results

Before digging into the reaction following earnings, let’s take a look at the numbers. Yelp announced quarterly results that beat expectations, with $36.4 million, a 63% year-over-year gain. The company’s net loss was $2 million, or an EPS of ($0.03), compared to ($0.24) last year.

Concerns

The big concern that caused shares to fall was guidance. The company said that it expects Q4 revenue between $40 and $40.5 million, which is in-line with expectations of $40.40 million. This would represent significant year-over-year gain, however it also fuels the belief that growth is slowing.

The company noted that its apps were used on eight million devices per month, up from 7.2 million in Q2. This transition to mobile is leaving questions about monetization, similar to Facebook ) earlier this year.

Facebook has seemingly fixed the problem with mobile, and although late to the party, has said that its mobile ads have been more effective than traditional desktop ads. Now, we are seeing other social media companies implement the same marketing tools used by Facebook on mobile, although these changes take time to produce profits.

Yelp is seeing a similar transition to Facebook, as more-and-more users switch to mobile over PCs. The company said that 45% of all searches are now performed on mobile. Therefore, with the company’s growing mobile presence, combined with slower growth, some are concerned that YELP may be facing a problem with monetizing its growing audience.

Takeaway

At this point the concerns surrounding Yelp are speculative. The only real measurable concern on the company’s earnings was an 11% fall in revenue per new business account, further allowing speculation to build that the company’s not ready for mobile.

If Yelp reaches its guidance for Q4, then its growth would be almost equal to its Q3 quarter. Therefore, 63% revenue growth isn’t bad by any measure. But when you consider that Yelp trades at 13.72 times next year’s sales and has a forward P/E ratio of 358.67, then you begin to see that the stock is priced for perfection.

Yelp is a company that because of its valuation must continue to exceed expectations, and see market leading growth. Even if the company was to maintain 60% growth over the next year, and traded flat, its price/sales would still be near 6.0, which is very expensive. However, the company will most likely not maintain growth of 63%, as its growth has slowed each and every year since 2008.

The Bottom Line

The stock is just too expensive, and now that questions are starting to emerge, it might continue to fall until finding a price that takes into account slowed growth and a proper valuation. The company has 35.10% of its shares short as of October 15, which means it could get uglier before getting better.

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BrianNichols owns shares of Facebook. The Motley Fool owns shares of Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Facebook. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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