When’s the last time you saw a company trading for almost 1,000 times earnings? Never? Me neither. That is, until I took a look at what may be the US market’s most expensive stock, LinkedIn (Nasdaq: LNKD). The Web company recently traded at 890 times earnings.
Yes, for real. That’s 8-9-0. So bowled over was I by this astounding number, I went around all last weekend telling people about it.
“It’s 1999 all over again,” said my dad, shocked and horrified, the ghost of a lost eToys investment flickering in his eyes. “How does that website even make any money?”
It’s OK, Dad: It’s got a business model
If you, like my dad, have a LinkedIn profile but are otherwise unfamiliar with the site, it may be helpful to know that LinkedIn does in fact have a viable business model in place. The company generates revenue by selling advertising on the site and by selling premium subscriptions to members. It also sells access to members and their information, with headhunters, recruiters, and other hiring agents among its customer base.
In its latest 10-K, LinkedIn summarises its model this way: “We believe this monetisation strategy properly aligns objectives among members, customers and our entire network and supports our financial objective of sustainable revenue and earnings growth over the long term.” Hiring managers want to hire, and people want to be hired.
As my colleague Dave Meier recently put it, “LinkedIn has brought career management to the cloud, and people are flocking to the platform. Management remains focused on giving members what they need to manage their careers while offering customers access to an engaged audience.”
What “access” means in this context is key, however, so keep your eye on that ball.
Don’t buy this at home
Last year, LinkedIn reported revenues of US$522 million and earnings of US$11.9 million, for year-over-year revenue growth of 114%. LinkedIn’s capital expenditures, SG&A, and R&D expenses remain high — the company is expanding its sales force and opening overseas offices, among other projects — yet, on the plus side, the company is financing its growth from cash. Its balance sheet is solid, boasting nearly US$578 million in cash and no debt.
Of course, it’s going to take a very great deal of “sustainable revenue and earnings growth over the long term” to bring LinkedIn’s stock back to earth. So don’t buy this at home, at least not yet.
Weighing LinkedIn’s long-term prospects
It’s not that I don’t believe there’s a place in the market for LinkedIn. It’s achieved the critical mass that makes a social media site truly useful, and new features like “Apply with LinkedIn” and the stalk-and-be-stalked “Who’s Viewed Your Profile?” feature make the site even stickier. (Yes, spending time on LinkedIn is mostly a waste of time, but c’mon. At a certain point, the central dramas of life are professional rather than romantic, and you may be more interested in where your old college frenemy is working than in the baby photo on your high school ex’s Facebook profile.)
It’s this activity and user information that may be behind LinkedIn’s $10 billion valuation. Facebook, Google (Nasdaq: GOOG) and even smaller companies like TripAdvisor (Nasdaq: TRIP) generate advertising revenue because of the detailed information they have about their users. Yes, without user data, even Facebook, Google, and TripAdvisor look like the now-departed GeoCities. LinkedIn has access to similar data, and it’s not only advertisers who want it. Hiring managers do, too.
All the same, it’s extremely tricky to assign valuation to a nascent data product, and in the case of LinkedIn right now, pretty much impossible. Take Mr. Market’s word for it at your own peril.
In our market, most similarly huge (well, okay, we can’t really compare!) multiples tend to be because of single years of (hopefully) depressed earnings, but it does give a sense of the faith investors are showing in management to make sure that last year’s foibles really are one-off. In other cases, investors are buying into the growth that is hopefully ahead. ASX 300 companies with sky-high price/earnings multiple based on Thursday’s closing price (and allowing for the fact they’re likely distorted) include Macmahon Holdings (ASX: MAH) at 514 times last year’s earnings, 307 for Indophil Resources (ASX: IRN), 252 for Rex Minerals (ASX: RXM), and Tanami Gold (ASX: TAM) at 217 times.
There are another 6 companies trading at over 50 times last year’s earnings and a further 13 at over 30 times.
That’s a whole lot of faith being placed in the hands of management.
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A version of this article, written by Catherine Baab-Muguira originally appeared at fool.com