Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Today is not looking like it's going to be a great day to own Yelp (NYSE: YELP) stock.
Last night, the website that's become synonymous with the idea of reviewing businesses online reported its fiscal third-quarter financial results. Earnings came out great, with Yelp reporting an adjusted profit (i.e., pro forma earnings) of $0.43 per share, versus the $0.35 that Wall Street had been expecting. Problem was, Yelp also reported its sales number for Q3, and at $241.1 million, it was not only about $4 million short of analyst estimates -- but also up just 8% year over year.
If you'd expect news like this to generate a negative reaction on Wall Street, you'd be right. Already, TheFly.com has tallied no fewer than three analysts (Deutsche Bank, JPMorgan, and Wedbush) downgrading Yelp stock, and three more (R.W. Baird, RBC Capital, and Stifel Nicolaus) cutting their price targets.
Here's what you need to know.
Irked analysts visit Yelp earnings report, comment, "Portions are too small." Image source: Getty Images.
Yelp misses on revenue
Let's start with the raw numbers. Yelp reported profits of $0.17 per diluted share in Q3 (this is the actual GAAP figure, as opposed to the often-inflated adjusted earnings number that Wall Street earnings estimates focus on, and that companies often choose to highlight). In Yelp's case, however, the GAAP number itself was pretty good -- nearly twice the $0.09 per share that Yelp earned in 2017's third quarter.
Rather, revenue was the problem at Yelp. Total revenue growth was a mere 8% -- not a good starting point for a company that Wall Street analysts (according to S&P Global Market Intelligence ) are expecting to grow earnings at 23% annually over the next five years. In its Q3 2018 letter to shareholders, Yelp explained that the reason revenue growth slackened in Q3 was because of a strategic move the company is making to "transition to selling local advertising without an initial term commitment" in order "to bring new advertisers to Yelp and increased new account acquisition."
In other words, in order to lower barriers to entry and get more business customers to sign on as Yelp advertisers, the company has stopped requiring them to contract long-term, and switched to a "dynamic" model in which customers can sign up and sign off more freely.
On the one hand, this move achieved its intended purpose: "In the first nine months of 2018, we onboarded over 60% more new advertisers than in any comparable timeframe in Yelp's history," says management. On the other hand, though...well, there's the Q3 revenue number, for one thing. But for another thing, Yelp was forced to issue new guidance yesterday warning that full-year 2018 revenue is now likely to come in at only about $940 million.
Wall Street was looking for $963 million.
Wall Street panics
How did Wall Street react to that news? You can read for yourself. Here are a few summaries TheFly.com has already gathered from today's analyst reports:
- Growth is "flat-lining" at Yelp, and "guidance calls for slower growth at higher margins." (R.W. Baird)
- "While the transition to nonterm contracts reduces purchasing friction and offers local businesses more flexibility in purchasing ads, it also appears to be causing unexpected volatility in paying accounts." (Stifel Nicolaus)
- Yelp's no-term-contract strategy "completely fell apart" in Q3. (Wedbush)
- Yelp suffers from "multi-year inconsistency" in sales growth, and there is only "limited upside" in the shares. (JPMorgan)
So, yeah, they're kind of upset. From price targets that ranged as high as $62 (RBC Capital), these analysts are now variously valuing Yelp stock at between $32 and $38 a share. Worse, investors have sold off the stock by nearly 30% this morning, and Yelp is currently fetching closer to just $31 a share.
Should you panic, too?
Are they right? Have things gone so bad, so fast at Yelp that this stock is now worth 30% less than it was just 24 hours ago?
The good news here is that I don't necessarily believe they are right -- neither the analysts nor the investors who are selling Yelp stock today. Consider that over the last 12 months, Yelp generated nearly $130 million in positive free cash flow (FCF) from its business (and this was over and above the cash generated from its sale of Eat24 to GrubHub back in last year's Q4). Weighed against these cash profits, Yelp has a $2.6 billion market capitalization after today's sell-off, and more than $800 million cash in the bank -- giving the company an enterprise value (EV) of just $1.8 billion.
At an EV/FCF ratio of just 14 today, Yelp actually looks pretty cheap to me if the company succeeds in growing earnings at the 23% annualized rate that Wall Street projects for it. Although it's true that Q3's sales growth rate of only 8% gives cause for concern, as R.W. Baird notes, Yelp's new business model appears to be designed to trade slower revenue growth for higher profit margin on the revenue (and witness the near-doubling in GAAP profit for proof that this is working out).
Accordingly, even with sales growth slowing, I think it's feasible for Yelp to keep growing earnings as planned -- and I think it's possible that today's sell-off is giving investors a good chance to buy into Yelp stock on the cheap.
10 stocks we like better than Yelp
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor , has quadrupled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Yelp wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of August 6, 2018
Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends Yelp. The Motley Fool has a disclosure policy .