For most of their histories as public companies, LinkedIn (Nasdaq:LNKD), the social network aimed at professionals, could do no wrong in the eyes of investors, while its larger rival Facebook (Nasdaq:FB) could do no right. Now, the roles are reversed.
LinkedIn shares tumbled 9.5% over the past two days after the Mountain View, California based company warned investors that its growth would be slightly less explosive than Wall Street had expected. Sales in the fourth quarter will be between $415 million to $420 million, a gain of more than 35%, which isn't too shabby. But since that's below the $438.9 million analysts forecast and lags the 81% sales gain in the most recent quarter, investors have interpreted this as really bad news.
Not surprisingly, Wall Street analysts are arguing that LinkedIn may have run into the challenge of "The Law of Large Numbers," the notion that companies have a tougher time growing as they get larger. LinkedIn certainly seems to be a case study for this theory. As Bloomberg News notes, the site claims 259 million members, a 38% year-over-year gain. That's below the 43% increase a year earlier. Sales in LinkedIn's talent solutions business "only" soared 62% in the quarter versus a 95% gain seen in the year ago period.
Before its recent run-up, pundits had argued that Facebook was a "victim" of the law until the pioneering social network managed to prove to Wall Street that it could monetize its mobile business better than Wall Street had expected. During the latest quarter, Facebook again blew away the expectations of Wall Street analysts in its quarterly results, sending its shares soaring. Some pundits have also argued that Apple (Nasdaq:AAPL), another former high-flying stock, has also been tripped up by the law. They also made the same argument about Google (Nasdaq:GOOG).
Getting back to LinkedIn, Reuters is arguing that the company's earnings guidance is being "conservative" and quotes analyst Kerry Rice of Needham & Co. as saying the company had guided conservatively for the past few quarters only to exceed its initial estimates. The polite term for that on Wall Street is "managing" earnings expectations. Unfortunately for investors, past performance does not indicate future returns.
LinkedIn is an expensive stock with a price-to-earnings multiple topping 700. Analysts are forecasting better growth for LinkedIn, expecting its revenue to surge more than 55% this year, about 10 percentage points higher than the growth expected for Mark Zuckerberg's company. Both stocks only make sense for investors with a high tolerance for risk.
The Bottom Line
When analysts start talking about “The Law of Large Numbers," oftentimes that's a sign that they don't know what to expect from a company. Investors need to remember that for every company that is "slowed" by the law, others such as Google and Facebook managed to overcome this obstacle. Though growth may have slowed for now at LinkedIn, it's not inconceivable that it could speed up again. But investors should wait for the price to pull back before adding the shares to their portfolio.
Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.