Groupon's Dip and an Incorrect Call Teach an Important Lesson

NEW YORK (TheStreet) -- My recent buy recommendation on Groupon (GRPNcompletely missed the mark -- to put it mildly. That has caused me to rethink my stock evaluation process. The stock (then) traded at $6.46.

Groupon's stock closed Wednesday at $5.76, down 1.71%. Shares have plummeted 51% year to date.

Since my bullish recommendation a week ago, Groupon has lost almost 11% of its value. And given the company's struggles with rising costs and competition for advertising dollars, things won't rebound anytime soon. At the time, I said:

From my vantage point, there is at least 40% upside in shares of Groupon in the next 6 to 12 months. During that span the stock should reach $9 on the basis of margin expansion, cost-reduction and free cash flow growth.

Clearly, I was wrong. The most important lesson learned was this: Though the market may be inefficient, it's not always wrong. There's a difference.

Matching Groupon's growth forecast with that of other Internet/retail companies such as Amazon (AMZN) (price-to-earning ratio of 157) and Facebook (FB) (P/E of 35) was not enough. My mistake was looking at Groupon's forward P/E of 25 and thinking that it implies value.

Instead, I should have looked at Groupon's underlying operation and the company's prospects to make money. As it stands, management's plan to transform the company is falling short of expectations, despite what its recent 26% revenue growth rate might suggest.

The other thing is, while Groupon's gross billings have improved, that alone does not signal the level of strength that this metric would ordinarily indicate. Gross billing is the metric that reflects the total dollar value of customer purchases of goods and services, excluding applicable taxes and net of estimated refunds.

But as long as expenses continue to increase, gross billings won't reach the bottom line. Groupon is investing in a new platform that allows merchants to offer their own deals. There is no guarantee that this platform will take off. Part of the problem is that Groupon can operate only in markets that its merchants create. It can't create its own.

The company could not be reached for comment.

But I'm curious about the company's plan to turn this deals model into a long-term sustainable business. It's going to cost money -- likely more than the company would like to spend. And if Amazon, which the market loves, can get punished for declining profits, it's going to be a while for Groupon to gain any trust.

This is because the company must fight the two-headed advertising monster known as Facebook and Google (GOOGL). And with Twitter's (TWTR) recent progress in video ads, Twitter may eventually seize what ad dollars there is left for Groupon. And if Yahoo! (YHOO) ever figures out its mobile/social strategy, Groupon will be squeezed out even more.

All told, Groupon is a stock I've always wanted to like. The value just wasn't there when I made the call. And it looks as if that value may not be realized in a while.

The company is approaching a couple of quarters of easier year-over-year comparisons. So the stock may find some support at its current level. But it's not worth the gamble, with so many better opportunities out there -- not to mention better deals.

At the time of publication, the author held no positions in any of the stocks mentioned, although positions may change at any time.

Follow @Richard_WSPB

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.


Now let's look at TheStreet Ratings' take on some of these stocks.

TheStreet Ratings team rates GROUPON INC as a Sell with a ratings score of D. TheStreet Ratings Team has this to say about their recommendation:

"We rate GROUPON INC (GRPN) a SELL. This is driven by multiple weaknesses, which we believe should have a greater impact than any strengths, and could make it more difficult for investors to achieve positive results compared to most of the stocks we cover. The company's weaknesses can be seen in multiple areas, such as its deteriorating net income, disappointing return on equity, weak operating cash flow, generally disappointing historical performance in the stock itself and feeble growth in its earnings per share."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The company, on the basis of change in net income from the same quarter one year ago, has significantly underperformed when compared to that of the S&P 500 and the Internet & Catalog Retail industry. The net income has significantly decreased by 846.8% when compared to the same quarter one year ago, falling from -$3.99 million to -$37.80 million.
  • Current return on equity is lower than its ROE from the same quarter one year prior. This is a clear sign of weakness within the company. Compared to other companies in the Internet & Catalog Retail industry and the overall market, GROUPON INC's return on equity significantly trails that of both the industry average and the S&P 500.
  • Net operating cash flow has significantly decreased to -$20.72 million or 336.49% when compared to the same quarter last year. In addition, when comparing to the industry average, the firm's growth rate is much lower.
  • Despite any intermediate fluctuations, we have only bad news to report on this stock's performance over the last year: it has tumbled by 26.94%, worse than the S&P 500's performance. Consistent with the plunge in the stock price, the company's earnings per share are down 500.00% compared to the year-earlier quarter. Naturally, the overall market trend is bound to be a significant factor. However, in one sense, the stock's sharp decline last year is a positive for future investors, making it cheaper (in proportion to its earnings over the past year) than most other stocks in its industry. But due to other concerns, we feel the stock is still not a good buy right now.
  • GROUPON INC has experienced a steep decline in earnings per share in the most recent quarter in comparison to its performance from the same quarter a year ago. The company has reported a trend of declining earnings per share over the past year. However, the consensus estimate suggests that this trend should reverse in the coming year. During the past fiscal year, GROUPON INC reported poor results of -$0.14 versus -$0.10 in the prior year. This year, the market expects an improvement in earnings ($0.11 versus -$0.14).

TheStreet Ratings team rates AMAZON.COM INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate AMAZON.COM INC (AMZN) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its robust revenue growth, largely solid financial position with reasonable debt levels by most measures and expanding profit margins. However, as a counter to these strengths, we also find weaknesses including unimpressive growth in net income, weak operating cash flow and relatively poor performance when compared with the S&P 500 during the past year."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • The revenue growth came in higher than the industry average of 0.4%. Since the same quarter one year prior, revenues rose by 23.1%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • Although AMZN's debt-to-equity ratio of 0.29 is very low, it is currently higher than that of the industry average.
  • 36.46% is the gross profit margin for AMAZON.COM INC which we consider to be strong. It has increased from the same quarter the previous year. Regardless of the strong results of the gross profit margin, the net profit margin of -0.65% trails the industry average.
  • In its most recent trading session, AMZN has closed at a price level that was not very different from its closing price of one year earlier. This is probably due to its weak earnings growth as well as other mixed factors. We feel that the combination of its price rise over the last year and its current price-to-earnings ratio relative to its industry tend to reduce its upside potential.
  • The company, on the basis of change in net income from the same quarter one year ago, has significantly underperformed when compared to that of the S&P 500 and the Internet & Catalog Retail industry. The net income has significantly decreased by 1700.0% when compared to the same quarter one year ago, falling from -$7.00 million to -$126.00 million.

TheStreet Ratings team rates FACEBOOK INC as a Hold with a ratings score of C+. TheStreet Ratings Team has this to say about their recommendation:

"We rate FACEBOOK INC (FB) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its robust revenue growth, largely solid financial position with reasonable debt levels by most measures and impressive record of earnings per share growth. However, as a counter to these strengths, we find that the stock itself is trading at a premium valuation."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • FB's very impressive revenue growth greatly exceeded the industry average of 11.5%. Since the same quarter one year prior, revenues leaped by 60.5%. Growth in the company's revenue appears to have helped boost the earnings per share.
  • FB's debt-to-equity ratio is very low at 0.02 and is currently below that of the industry average, implying that there has been very successful management of debt levels. Along with this, the company maintains a quick ratio of 12.48, which clearly demonstrates the ability to cover short-term cash needs.
  • Net operating cash flow has slightly increased to $1,341.00 million or 1.43% when compared to the same quarter last year. Despite an increase in cash flow, FACEBOOK INC's cash flow growth rate is still lower than the industry average growth rate of 17.69%.
  • Current return on equity exceeded its ROE from the same quarter one year prior. This is a clear sign of strength within the company. When compared to other companies in the Internet Software & Services industry and the overall market, FACEBOOK INC's return on equity is below that of both the industry average and the S&P 500.

TheStreet Ratings team rates GOOGLE INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:

"We rate GOOGLE INC (GOOGL) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. The company's strengths can be seen in multiple areas, such as its revenue growth, largely solid financial position with reasonable debt levels by most measures and reasonable valuation levels. However, as a counter to these strengths, we also find weaknesses including a generally disappointing performance in the stock itself, disappointing return on equity and feeble growth in the company's earnings per share."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • GOOGL's revenue growth has slightly outpaced the industry average of 11.5%. Since the same quarter one year prior, revenues rose by 13.1%. This growth in revenue does not appear to have trickled down to the company's bottom line, displayed by a decline in earnings per share.
  • Although GOOGL's debt-to-equity ratio of 0.05 is very low, it is currently higher than that of the industry average. Along with this, the company maintains a quick ratio of 4.14, which clearly demonstrates the ability to cover short-term cash needs.
  • The gross profit margin for GOOGLE INC is rather high; currently it is at 63.35%. Regardless of GOOGL's high profit margin, it has managed to decrease from the same period last year. Despite the mixed results of the gross profit margin, the net profit margin of 21.44% trails the industry average.
  • Despite any intermediate fluctuations, we have only bad news to report on this stock's performance over the last year: it has tumbled by 35.80%, worse than the S&P 500's performance. Consistent with the plunge in the stock price, the company's earnings per share are down 32.58% compared to the year-earlier quarter. Naturally, the overall market trend is bound to be a significant factor. However, in one sense, the stock's sharp decline last year is a positive for future investors, making it cheaper (in proportion to its earnings over the past year) than most other stocks in its industry. But due to other concerns, we feel the stock is still not a good buy right now.
  • The company's current return on equity has slightly decreased from the same quarter one year prior. This implies a minor weakness in the organization. Compared to other companies in the Internet Software & Services industry and the overall market on the basis of return on equity, GOOGLE INC has outperformed in comparison with the industry average, but has underperformed when compared to that of the S&P 500.

TheStreet Ratings team rates YAHOO INC as a Buy with a ratings score of B. TheStreet Ratings Team has this to say about their recommendation:

"We rate YAHOO INC (YHOO) a BUY. This is driven by a number of strengths, which we believe should have a greater impact than any weaknesses, and should give investors a better performance opportunity than most stocks we cover. The company's strengths can be seen in multiple areas, such as its largely solid financial position with reasonable debt levels by most measures, reasonable valuation levels, solid stock price performance, good cash flow from operations and expanding profit margins. We feel these strengths outweigh the fact that the company has had sub par growth in net income."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

  • Although YHOO's debt-to-equity ratio of 0.09 is very low, it is currently higher than that of the industry average. Along with this, the company maintains a quick ratio of 2.99, which clearly demonstrates the ability to cover short-term cash needs.
  • Net operating cash flow has slightly increased to $357.41 million or 8.03% when compared to the same quarter last year. Despite an increase in cash flow, YAHOO INC's average is still marginally south of the industry average growth rate of 17.69%.
  • Compared to its closing price of one year ago, YHOO's share price has jumped by 30.19%, exceeding the performance of the broader market during that same time frame. Looking ahead, the stock's sharp rise over the last year has already helped drive it to a level which is relatively expensive compared to the rest of its industry. We feel, however, that other strengths this company displays justify these higher price levels.
  • The gross profit margin for YAHOO INC is currently very high, coming in at 83.10%. Regardless of YHOO's high profit margin, it has managed to decrease from the same period last year. Despite the mixed results of the gross profit margin, YHOO's net profit margin of 24.87% compares favorably to the industry average.

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