Finally, Demand Media is still largely dependent on Google Inc (NASDAQ:GOOG)’s search algorithms. Demand Media makes more money the more people visit its websites, which is highly dependent on where eHow and related websites appear in search result rankings. Search result logarithm changes can throw off traffic until Demand Media adjusts its content. This is exactly what happened in 2011: Google’s Panda algorithm change resulted in a massive traffic and quarterly revenue drop. In response, Demand Media reworked its business model, culling particularly bad content from its sites, tightening its editorial guidelines, and attempting to link content into other websites and social media.
The adjustment got Demand Media’s traffic back up, but it did not resolve the company’s reliance on Google’s algorithms. Demand Media is just as vulnerable to future Google updates, particularly if, like the 2011 Panda update, they target mass produced content.
Demand Media is an extremely risky and expensive small cap headed for short-term volatility and long-term losses. Wednesday’s jump is due to speculations on a possible sale, not to concrete changes in the company’s underlying business structure or profitability.
The jump means that the company is priced as a highly speculative growth stock. However, unless you believe in the transformative power of getting directions from eHow, buying Demand Media now is either a poor bet on innovation and value-added products, or a cynical bet on internet literacy.
The article Don’t Buy Market Optimism for this Stock originally appeared on Fool.com and is written by Calla Hummel.
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