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Three Important Lessons from the LinkedIn (LNKD) Stock Collapse

For years, LinkedIn (LNKD) stock defied value investors, advancing with little interruption despite price-to-earnings ratios that were consistently well into triple digits. Last month was its comeuppance.

A disappointing earnings report was enough to nearly cut LNKD’s value in half, as the stock plummeted from 192 to 108 literally overnight. Actually, the earnings themselves weren’t bad—sales improved 34% from a year ago, while non-GAAP earnings per share also increased. What sparked the LinkedIn stock selloff was its weak guidance for the current quarter: $0.55 per share of non-GAAP earnings on sales of $820 million, figures that were well shy of the $0.75 EPS and $868.3 million that were expected.

It doesn’t sound like enough of a reason to punish LNKD to the tune of a 44% overnight evisceration. But it just goes to show that investors were looking for a reason—any reason—to sell LinkedIn stock, especially in this flimsy market. Almost instantly, LinkedIn went from a booming market success to a cautionary tale.

What can we learn from the LinkedIn debacle, other than don’t buy LinkedIn stock right now? There are a number of helpful lessons.

1. Valuation is important in the current market climate. LNKD got away with trading at more than 100 times earnings—and as high as 1,000 times earnings—for much of its first four years after coming public in 2011. In a cratering market environment such as this, that kind of lofty valuation sticks out like a sore thumb—particularly when the company’s earnings growth has been so inconsistent. Which brings me to my next point…

2. Revenue growth can’t cure all ills. Though the $820 million in sales LinkedIn expects to bring in this quarter was deemed a disappointment, it’s a 28% improvement from a year ago. However, it also represents yet another slowdown in LinkedIn’s revenue growth: from 35% in 2015, 45% in 2014, 57% in 2013, 86% in 2012, and 115% in 2011. During that time, the company’s per-share earnings have been all over the place, finishing in the red each of the last two years. Triple-digit and high-double-digit sales growth can mask uneven earnings. As LinkedIn’s sales growth has slowed each year, LinkedIn stock has become a tougher sell.

3. A company’s name can only get it so far. A lot of people use LinkedIn—414 million people, to be exact. You may have a LinkedIn account yourself. It’s a great way to connect with other professionals and perhaps plant the seed for a future job. That name recognition and brand familiarity likely helped the stock through its first few years. “Buy what you know,” as Warren Buffett always says; and a lot of people know LinkedIn. It’s the same reason investors flocked to Twitter (TWTR) in its very early days before everyone realized the company wasn’t making any money—and still isn’t. LinkedIn has been in the black at times, but never consistently. Now that its earnings are taking another step backward, the realities of slowing sales and a harsh market have set in.

The Bottom Line

It’s telling that even after losing nearly half its value in 24 hours, LinkedIn stock has yet to bounce back. Value experts—including our own Roy Ward—aren’t suddenly viewing LNKD as a bargain. Not with such a grim forecast for the current quarter, and year for that matter.

There are a lot of stories similar to LinkedIn out there right now: once high-flying growth stocks that have been stuck in the mud amid this six-month market decline. Stocks like LNKD can get by on smoke and mirrors in a bull market like the one that was in place for its first four years of trading. But now there’s nowhere to hide, and any sign of weakness can result in a feeding frenzy.

It’s best to wait until the bears have finished eating their dinner before investing in a company with a chart and numbers that look like LinkedIn’s.

Jacob Mintz is a professional options trader and editor of Cabot Options Trader. Using his proprietary options scans, Jacob creates and manages positions in equities based on unusual option activity and risk/reward.