Groupon's Troubles Were Written on the Wall

By Michael Tarsala, Covestor

BOSTON ( TheStreet) -- You didn't need an accounting degree to see Groupon's restatement mess coming.

Bloggers, journalists and professors had raised detailed concerns about its books ahead of its November initial public offering. But there was no stopping the surge of market orders on the company's first day of trading.

Fast forward to April. Groupon's market value has been been cut in half. It is now facing the extra scrutiny investors probably should have given the company in the first place. And the SEC may now be getting involved.

There's a group out there saying "I told you so." And, truly, they did.

Groupon is now a case study in why every investor needs to apply due diligence and skepticism when it comes to trendy stocks.

There are three main Groupon takeaways for every investor:

Read the details

This part is not that hard or time consuming: For your biggest individual investments, you should visit the SEC Edgar site and read the latest filings. In Groupon's case, that's where some of the first red flags surfaced.

In its IPO filing, Groupon acknowledged its management team has "limited experience" with regulatory compliance, a problem that seemed to persist for months. And the filings would have tipped you off to a previous revenue correction.

Also, blogs such as the daily linkfest at Abnormal Returns and Josh Brown's The Reformed Broker are now required reading. Brown, in particular, has been a consistent Groupon critic. Blogs helped to popularize questions from professors Ed Ketz and Tony Catanach about Groupon's accounting and internal controls. Those same professors were among the first to wonder out loud if Groupon was cooking its books.

If you don't understand it, avoid it

Warren Buffett is famous for this advice. And who am I to argue?

In Groupon's case, we're talking about a company that invented its own financial metric: Adjusted Consolidated Segment Operating Income. How's that for simplicity?

I can appreciate operating earnings (EBITDA, as an example) as a way to better understand earnings trends. Yet I had never heard of adjusted CSOI until Groupon came along, which was set up to exclude its marketing expenses. Keep in mind, marketing is essentially Groupon's business! Eric Savitz at Forbes brought the controversial metric to the fore 10 months ago.

And writers including Rocky Agrawal illuminated the Groupon business model in a post that said the company acts as a "subprime lender" to small businesses.

Expect perfection when the stock is priced that way

Groupon reached a market cap of nearly $20 billion on its first day, trading at about 9 times sales. As Business Insider's Henry Blodget pointed out, the typical online media company trades at just 3 to 8 times sales.

No doubt, you can expect to pay more for a company with better-than-average growth prospects. But for a higher-than-average price, you also should be getting a higher-than-average trust factor. And after its restatement, that is where Groupon now appears to be struggling.

Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information, and should not be construed as recommendations or advice. Information from Model Managers and third-party sources are deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models are available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures. For information about Covestor and its services, go to covestor.com or contact Covestor Client Services at (866) 825-3005, x703.

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