Don’t Make This Mistake With Groupon Stock (GRPN)

Groupon (GRPN) stock has been volatile since its breakout quarter. Groupon stock has more than doubled since Feb. 11, yet it remains down 40% over the last year, and 80% since its IPO in 2011.

groupon stock grpnTherein lies the reason why investors are likely to make a huge mistake with Groupon stock.

Since GRPN is still far from its 52-week and all-time high, and has finally started to trade higher, some investors will conclude that Groupon stock is still cheap after its big, recent gains. Some will rationalize that since GRPN stock traded at $20-plus, and is now around $4.65, so there must still be room for it to surge higher. After all, GRPN stock could double again and still be 60% off its all-time high!

However, adopting the above narrative would be a huge mistake. The fact is, Groupon stock fell for a reason.

Over the past three years, GRPN’s trailing 12-month operating margin has fallen from 3.5% to a negative 2.5%, a huge difference in profitability. Also, the 50% growth that GRPN had produced in the year prior to its IPO, suddenly decelerated to 18%, and then single digits, and for the coming year analysts expect a 3% decline in revenue.

The reason for this decline in margin and revenue is simple: GRPN’s coupon business has dwindled away, and a lower margin e-commerce business that requires fulfillment costs has taken over.

During Groupon’s last quarter, its total billings fell 1%, but investors prioritized the fact that North American billings jumped 10%. Investors also seemed content with the fact that Goods revenue (e-commerce) jumped 10% to more than $600 million, now accounting for 65% of total revenue.

In other words, 65% of Groupon’s business is performing quite well. However, the other 35% is not performing nearly as well, and unfortunately it’s the part of Groupon’s business that generates high margins.

What’s Groupon Stock Worth?

The bottom line is that there is a legitimate reason that Groupon stock has fallen by such a large degree over the last few years. The company’s lack of growth and margin deterioration are to blame, and investors cannot assume that GRPN stock is cheap just because it used to trade north of $20.

Instead, its operating performance must dictate the appropriate valuation.

Groupon had $853 million in cash & equivalents to end last year. The company also had $208 million in free cash flow in 2015, which is the income that Groupon earned from operations minus capital expenditures. Personally, I prefer to look at free cash flow as the best metric of a company’s bottom line performance, as it can not be manipulated by one time costs or gains like net income.

If you subtract the $853 million in cash & equivalents from Groupon’s market capitalization, then GRPN is worth $2.15 billion. Therefore, GRPN stock (minus cash) trades at just 10 times FCF.

Yes, that is very cheap, but GRPN lacks growth, and 10 times FCF is much more appropriate than, say, 20x FCF.

In all fairness, 10 to 13 times FCF is a multiple that I would consider fair for Groupon stock. However, determining what’s fair is a personal preference, figuring how much risk you are willing to take, and realizing that as a stock gets more expensive, there are naturally higher risks that come with it.

Regardless, I would not look at GRPN stock as one that’s headed back to $20, or even $15. Instead, $4.75 to $6 looks fair, and with the stock up so much over the last couple weeks, it might not be a bad idea to take some profits off the table.

As of this writing, Brian Nichols was long GRPN.

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