Yelp Inc (NYSE:YELP) has benefited from several secular growth tailwinds over the past several years. Yet, YELP stock hasn’t done much besides fall off its highs.
Digital food ordering is a huge growth tailwind. The at-home economy is here and part of that economy is ordering food in as opposed to eating out. Yelp should be a big winner in this transition.
Digital advertising is also a huge growth tailwind. Ad dollars continue to shift en masse from traditional mediums to digital channels. Yelp should also be a big winner in this transition.
But despite those growth tailwinds, YELP stock has fallen 25% over the past 3 years, versus a 25% gain for the S&P 500.
That is pretty crazy to think about. Digital food ordering peer GrubHub Inc (NYSE:GRUB) has risen 85% in that time frame. Digital advertising peers Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOG,NASDAQ:GOOGL) have risen 140% and 90%, respectively, over the past 3 years.
How is this possible?
YELP stock has been the classic victim of too much hype creating an inflated valuation. That valuation is still unwinding today. With competitive risks only increasing, YELP stock still has a ways to fall before it’s a good long-term investment.
The Valuation on YELP Stock Makes No Sense
YELP stock trades at a rather absurd 270 fiscal 2017 price-to-earnings multiple.
In terms of valuation, that puts YELP stock in the ballpark of Netflix, Inc. (NASDAQ:NFLX) and Amazon.com, Inc. (NASDAQ:AMZN). In fact, YELP stock trades at a richer 2017 valuation than both NFLX and AMZN.
Does that really make sense? No.
Netflix is the undisputed leader in the secular growth over-the-top streaming video market. Revenues are expected to grow more than 30% this year, and just under 30% next year. Earnings growth over the next 5 years is expected to be about 60% per year.
Amazon is the undisputed leader in the secular growth e-commerce and cloud infrastructure markets. Revenues are expected to grow more than 30% this year, and just under 30% next year. Earnings growth over the next 5 years is expected to be about 60% per year.
Yelp, meanwhile, is just another player in the overcrowded digital food discovery and ordering market. Revenues are expected to grow just 18% this year and 13% next year. Earnings growth over the next 5 years is expected to be about 30% per year.
Long story short: Yelp is a low-growth, low-moat player relative to Netflix and Amazon. Consequently, YELP stock featuring a richer valuation than AMZN and NFLX makes no sense.
The Yelp Growth Story Is Slowing
Perhaps more concerning is that the market is giving YELP a 270 earnings multiple for a growth narrative that is actually slowing down.
Revenues rose 30% last year. That growth rate has come down sharply this year (24% in quarter 1 to 20% in Q2 to 19% in Q3), driven by a step-down in both advertising and transaction revenue growth. By fiscal 2018, last year’s 30% growth rate is expected to shrink to just 13%.
Meanwhile, margin growth is also tapping out. Adjusted EBITDA margins rose 400 basis points last year. They rose 700 basis points in the first quarter of this year and 500 basis points in the second quarter. But they rose just 100 basis points in the third quarter.
With revenue growth coming down and margin growth tapping out, what will power YELP’s earnings growth trajectory? If adjusted EBITDA margins continue to grow only roughly 100 basis points year-over-year, while revenue growth continues to come down to roughly 10%, then earnings growth over the next 5 years will be a lot lower than 30% per year.
And that doesn’t even consider competition. Facebook just launched Facebook Local, which is essentially a direct hit at Yelp. Amazon, Alphabet, and Uber are also players in this space who are upping their games. With so much competition from bigger players, Yelp’s growth outlook over the next several years is actually quite bleak.
Bottom Line on YELP Stock
Yelp is way, way overvalued. Even if the company can grow earnings at 30% per year over the next 5 years, YELP stock doesn’t deserve a 270 2017 earnings multiple.
But growth over the next 5 years will likely be far less than 30%, given current eroding growth trends and elevated competitive risks.
That makes YELP stock unnecessarily risky at these levels. I wouldn’t be surprised to see this stock grind significantly lower over the next 12 months.
As of this writing, Luke Lango was long FB, AMZN, NFLX, GOOG and GRUB.
