Should You Buy This Company After a 45% Drop?

Angie's List has seen its price nosedive by 45% in October, showing how quickly the tide can turn for momentum stocks. But while the stock's performance could serve as a potential industry warning, is Angie's List now presenting value?

What happened?
Angie's decline was caused by the perfect combination of events. It all started on Sept. 30 when the company disclosed in an 8-K that Chief Technology Officer Manu Thaper was no longer employed. Thaper had been considered important in building the company's brand, with previous roles at MySpace, Yahoo, and Cisco.

Then, the company announced it was running a "reduced-price test" for subscriptions to gauge its impact. As we saw with Netflix a couple years back, sometimes the market views changing subscription prices as a sign of concern.

However, the ultimate stock-crushing moment came on Oct. 23, following Angie's quarterly report . The company slightly missed estimates on both the top line and bottom line, but apparently, given the cautious events before earnings, investors were taking no chances, and shares fell nearly 15%.

As a result, we are now looking at a stock that has fallen from $24 to nearly $13 in less than a month.

Keeping perspective
It's good to try and put things in perspective. Angie's List is part of an exciting new class of technology companies that operate through the web. There has been a lot of criticism surrounding Angie's List in recent quarters, as many believe that businesses are not actually rated fairly on their site, and can obtain a higher rating by paying Angie's List.

Nonetheless, when we put all rumors and speculation aside, there are only two numbers that really stick out to me: 56% and 4.3.

For Angie's List, 56% is the rate at which revenue grew year over year in the last quarter, and 4.3 is Angie's multiple on annual sales. Hence, with 56% top-line growth, Angie's List trades at 4.3 times sales.

To put this in perspective, Zynga is soaring higher by double digits after reporting third-quarter earnings. However, if you look at the two reports side by side, not knowing the company by name, it's clear who had the better quarter.

In the third quarter, Zynga's bookings (revenue) declined 40% year over year. Moreover, the online game company saw its daily active users decline 49% year over year and saw a 48% drop in research and development spending thanks to job cuts. Yet, despite all of these year-over-year declines, investors are buying the stock, while selling Angie's List.

Granted, no two companies are valued the same, and since stock performance is a reflection of earnings and expectations, it is possible that Zynga was valued to such a lower degree that its fundamental flaws could be seen as a positive. However, at 2.5 times sales, Zynga is not too much cheaper than Angie's List when considering that many in the space trade at 15 to 20 times sales. This disconnect between stock performance, fundamentals, and valuation might suggest that Angie's List is a good buy on the dip.

A clear disconnect
For some reason, Angie's List looks disconnected from the rest of its high-growth Internet company peers. Granted, analysts lowering their outlooks, high-profile executives leaving, and earnings that miss estimates all play a part in changing sentiment. However, investors simply can not ignore that Angie's List is cheap relative to the rest of its industry.

In the last year, Yelp has produced slightly less revenue than Angie's List. Both companies offer reviews to consumers and generate revenue through advertising, among other services. However, despite the similarity in annual sales, Yelp's market cap is higher by nearly sixfold.

Yelp bulls will note the company's explosive growth as the reason for its 25 times sales market capitalization. However, keep in mind that Angie's List has near identical growth. Therefore, we can identify a clear problem: Either Yelp faces an Angie's List-like fall, or Angie's List itself is particularly undervalued.

Final thoughts
The reality of the problem most likely lies somewhere in the middle. Yelp should not be trading at 25 times sales if the market is using fundamentals as a guide. Also, Angie's List should not have fallen 45% in a quarter where sales grew 56% year over year, especially when a company such as Zynga is seeing its shares rise despite a 40% top-line decline.

When you combine all of these factors, it suggests that Angie's List might be presenting value, while its peers might not.


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Brian Nichols has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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