Is LinkedIn a Bubble or a Buy?

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

Career-oriented social network LinkedIn (NYSE: LNKD), often referred to as the “Facebook (NASDAQ: FB) for professionals,” has defied market expectations and fundamental gravity to soar to all-time highs. Can LinkedIn keep surging despite trading at over 800 times trailing earnings, or will its bubble eventually burst when it is fails to meet the market’s high expectations?

Let’s examine LinkedIn’s growth trajectory, business model, fundamentals, and future plans to see if this stock is ticking like a fine Swiss watch or a bubbly time bomb.

R.I.P. Monster

LinkedIn burst onto the scene in 2003, and in three years it disrupted the corporate recruitment market, launching a torpedo through the hull of market leader Monster Worldwide (NYSE: MWW). Monster used an old-fashioned resume submission and job search format, while LinkedIn used a sprawling social networking format that stressed the importance of connections and recommendations. In the end, one graph is worth a thousand words.

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MWW data by YCharts

Today, with Monster Worldwide out of the picture and trying desperately to sell itself, LinkedIn’s only true industry peer is Facebook - which is mainly used for casual social connections with family and friends. For now, the two companies pursue two different paths of growth.

A Strong Fourth Quarter

In its fourth quarter, LinkedIn earned 35 cents per share, nearly double the analyst projection of 19 cents. Its revenue also trampled expectations, surging 81% to $303.6 million.

The Foolish Fundamentals

Although few analysts doubt LinkedIn’s growth potential, many have questioned the fundamentals of the company. Let’s first check the company’s financial health, and compare it to Facebook for some perspective.

<table> <tbody> <tr> <td> </td> <td><strong>Cash</strong></td> <td><strong>Debt</strong></td> <td><strong>Debt-to-Equity</strong></td> <td><strong>Profit Margin</strong></td> </tr> <tr> <td><strong>LinkedIn</strong></td> <td>$676.65 million</td> <td>0.00</td> <td>None</td> <td>2.04%</td> </tr> <tr> <td><strong>Facebook</strong></td> <td>$9.36 billion</td> <td>$2.36 billion</td> <td>20.04</td> <td>1.04%</td> </tr> </tbody> </table>

Source: Yahoo Finance

LinkedIn looks relatively healthy, but both social networks’ profit margins are quite slim. Despite generating the majority of their revenue from display ads, neither company can match Google (NASDAQ: GOOG), which has a 21.4% profit margin. Although LinkedIn’s lack of debt is encouraging, we should also check growth valuations.

<table> <tbody> <tr> <td> </td> <td><strong>Forward P/E</strong></td> <td><strong>5 yr. PEG Ratio</strong></td> <td><strong>P/S Ratio (ttm)</strong></td> <td><strong>Price to Book</strong></td> </tr> <tr> <td><strong>LinkedIn</strong></td> <td>59.37</td> <td>1.58</td> <td>15.94</td> <td>16.03</td> </tr> <tr> <td><strong>Facebook</strong></td> <td>36.73</td> <td>1.69</td> <td>13.41</td> <td>5.75</td> </tr> <tr> <td><em>Advantage</em></td> <td>Facebook</td> <td>LinkedIn</td> <td>Facebook</td> <td>Facebook</td> </tr> </tbody> </table>

Source: Yahoo Finance

Facebook appears more poised for growth than LinkedIn, as its stock is more fundamentally undervalued. Both social networks have shown an eventual, healthy convergence of share price with P/E ratios.

Facebook’s trailing P/E exceeds 1,000, but its forward multiple is a more reasonable 36.73. The same applies to LinkedIn, which trades at 800 times trailing earnings. That means despite LinkedIn’s high price and volatile price movements, the market has a better grasp of its true value, and is weighing it accordingly.

A Growing User Base

LinkedIn stated that it had over 200 million members by the end of 2012. The site also logged 155 million unique visitors in the fourth quarter, according to comScore, making it the 25th most visited website in the world. Visitors also visited 67% more individual pages than the prior year quarter, suggesting a much higher degree of engagement in job postings and searches.

The company has also logged a high number of mobile requests, with 27% of total visitors accessing the site from a smartphone or tablet, up from 15% in the prior year quarter.

LinkedIn recently introduced news feed advertisements, similar to Twitter and Facebook’s sponsored posts. This form of advertising is less intrusive and more cohesive, blending well into both desktop and mobile environments.

International Expansion

LinkedIn has also successfully expanded overseas, where the majority of its members are now based. Sales from international markets more than doubled to $114.6 million, accounting of 38% of its total revenue. The company stated that it was aggressively pursuing growing job markets in Hong Kong and Brazil, opening the floodgates to two major BRIC gateways.

Big Investments in Renovation and Innovation

LinkedIn reinvested much of its 2012 income into research and development for new products. During the year, the company’s product engineering segment introduced more new features than in any previous year.

One major change was the website redesign in July, which streamlined profile pages and added a blogging platform, “LinkedIn Influencers”, which features entries from high profile members such as Barack Obama and Sir Richard Branson. This blogging platform is a nod to Twitter’s success - where users often follow their favorite public figures and products instead of their real life acquaintances.

According to LinkedIn, page views across the site rose nearly 70% as a result of the site renovation.

The Road Ahead

Looking forward, LinkedIn forecasts revenue to grow by 48% to $1.44 billion next year. Although that would be a lofty goal for any company, LinkedIn has the numbers to back it up.

However, two threats loom on the horizon - Facebook and Google.

If Facebook introduces a new professional network, branching its social network into “casual” and “professional” profiles, then its 1 billion users could crush LinkedIn's 200 million. Facebook's recently introduced "Graph Search" technology could also simplify searches for both employers and prospective employees.

Google, which has already shown interest in disrupting the travel search industry, could also use Google+ as a foundation for building a job search network. Considering Google’s strong metasearch capabilities and ability to index social networks, it could easily add “Google Jobs” to its sprawling ecosystem.

The Bottom Line

With stabilizing fundamentals, investing in LinkedIn is no longer like walking on a tightrope. If its feverish P/E can reconcile with its rapid growth, then it could grow as fast as Google did last decade. The company is dominating a strong niche by successfully blending job search engines with social networking, and its overseas expansion into emerging markets is very encouraging. LinkedIn’s clean balance sheet, strong revenue growth and positive earnings all point to a solid long-term investment.

Leo Sun owns shares of Facebook. The Motley Fool recommends Facebook, Google, and LinkedIn. The Motley Fool owns shares of Facebook, Google, and LinkedIn. 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!

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