About a month ago, I outlined on InvestorPlace four big reasons why beaten-up Yelp (NASDAQ:YELP) stock was ready to rip higher.
At the time, YELP stock was at $18. Three weeks later, it had rallied more than 30% to $24.50, amid broad optimism regarding a gradual reopening of the U.S. economy and resumption of normal consumer activity.
Then JMP Securities released a bearish note on Yelp in mid-May. In it, JMP said:
“Yelp’s traffic is tied to brick and mortar visits and in-person services and while we expect traffic to improve as the U.S. removes COVID-19 related restrictions, Yelp is likely to see headwinds until we have a vaccine or treatment.”
YELP stock dropped big on the news. All the way back to $19.
And I think it’s time to buy the dip again. Yes, Yelp will see headwinds until we have a vaccine or treatment. But that’s already fully priced into the stock. What’s not priced in is the fact that the company’s financial trends will only get better from here as the U.S. economy normalizes. As that happens over the next few months, YELP stock will bounce back.
By a lot. Shares could even roar 75% higher by the end of the year.
Here’s how.
Things Will Get Better
Yelp’s fundamentals are awful right now. There’s little argument there. Consumers are rarely leaving their homes. Restaurants and local services across the globe are closed. Ad budgets have been slashed.
Right now, Yelp is being hit by a cocktail of headwinds. And the numbers reflect this. Yelp’s revenues in April dropped 35% year-over-year.
But this feels like rock bottom for Yelp.
Several states, including Georgia and Arizona, have let their stay-at-home orders expire. In those states, consumers are starting to go out again. Restaurants and local services are starting to open up. Presumably, this gradual economic normalization will lead to increased local ad spending in those states.
So, whereas everything was working against Yelp in April, some of the company’s headwinds have started to reverse course in May in certain geographies. In June and July, more states will let their stay-at-home orders expire. As they do, restaurant and local service traffic and spend will rebound in those states, and Yelp’s fundamentals will continue to improve, slowly but surely.
Big picture: things are bad right now for Yelp, but they are in the first inning of getting better. Over the next few months, the company’s fundamentals will dramatically improve amid global economic normalization and the reopening of local restaurants and services.
Huge Upside Potential
The attractive thing about YELP stock at $18 is that all the bad news is priced in, but none of the good news is priced in.
YELP stock trades at 1.6 times trailing sales. That’s an all-time low valuation for this stock. More than that, it represents a 60% discount to the stock’s five-year-average trailing sales multiple of 3.8.
Assuming Yelp’s revenue and profit growth trends do eventually normalize, then the stock is an absolute steal here at today’s majorly discounted valuation.
My modeling on Yelp is quite conservative. I assume a big revenue drop this year, and then mild, mid-single-digit revenue growth thereafter for the subsequent few years. I also assume a big drop in profit margins this year, followed by a gradual rebound in margins to 2019 levels by 2025.
Those aren’t wildly aggressive assumptions. If anything, they are quite conservative. Yet, they lay the groundwork for YELP stock to rally 75% over the next few quarters.
Under those assumptions, I see Yelp netting about $2.30 in earnings per share by 2025. Based on a 20-times forward earnings, which is about the medium-term average multiple for technology stocks, and a 10% annual discount rate, that implies a 2020 price target for YELP stock of over $31.
Bottom Line on YELP Stock
Yelp stock is oversold and undervalued at current levels. All the bad news is priced in. None of the good news is priced in. Over the next few months, the good news will start to pile up.
The economy will normalize. Local restaurants and services will reopen. Yelp’s growth trends will improve.
All of that good news will converge on a severely discounted valuation on YELP stock and spark a huge rally into the end of the year. I see prices above $30 as likely by the end of the 2020.
Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been rated one of the world’s top stock pickers by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm. As of this writing, he was long YELP.
