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LinkedIn Corp (LNKD), Zillow Inc (Z) & Facebook Inc (FB): Will Accelerated Growth Lead to Large Gains?

LinkedIn Inc.LinkedIn Corp (NYSE:LNKD) and Zillow Inc (NASDAQ:Z) have been industry favorites in the Internet space since Facebook Inc (NASDAQ:FB)’s IPO debacle.

As of July 24, Facebook had lost 30% of its value since becoming a public company. During that same period, LinkedIn Corp (NYSE:LNKD) and Zillow Inc (NASDAQ:Z) have both doubled. However, after Facebook Inc (NASDAQ:FB)’s quarterly results, it could now follow their lead.

The Gold Standard

Internet-based companies are valued on two metrics: Growth and potential. If a company has rapid growth and the market believes that growth is sustainable, then a company can trade well above its fundamentals. Such is the case for both Zillow and LinkedIn.

Zillow Inc (NASDAQ:Z) is an online real estate marketplace and earns its money through agent subscriptions and advertising. During their last quarter, revenue grew 70% year-over-year. Zillow has reported sales of $132 million over the last 12 months and has an operating margin of 1.1%.

LinkedIn is a social media company that focuses on career networking and jobs. The company makes its money through user subscriptions, advertising, and a number of new services. LinkedIn Corp (NYSE:LNKD) grew its Q1 revenue by 72% year-over-year and has operating margins of 6.3%.

Both LinkedIn and Zillow Inc (NASDAQ:Z) trade at 19 times annual sales, which judging by the performance of both stocks, seems to be the gold standard of valuing an Internet company.

Natural Growth

Theoretically, as a company grows larger its year-over-year revenue growth will slow. In biotechnology, a product has peak sales estimates, and a company is valued according to potential sales. This is no different for Internet companies, as investors must determine the fundamental upside for a job-based company (LinkedIn), a real estate marketplace (Zillow), or any other company when determining fair value.

LinkedIn Corp (NYSE:LNKD) validates the natural revenue slowdown that occurs with growth, as its last four quarters of year-over-year growth have been as follows:

Q2 2012 89%
Q3 2012 81%
Q4 2012 82%
Q1 2013 72%

The above chart shows that LinkedIn’s year-over-year growth is in fact decelerating as the company grows larger. However, LinkedIn Corp (NYSE:LNKD) maintains its 19 times sales valuation, showing that it’s still the preferred Internet company among investors.

A New Market Favorite?

As of Wednesday, Facebook traded at 11.5 times sales. However, the stock traded higher by nearly 20% in the after hours following its Q2 report.

In the quarter, Facebook Inc (NASDAQ:FB)’s revenue increased 51% year-over-year to $1.81 billion. Therefore, Facebook’s after-hour gains combined with its revenue gains would give the stock a price/sales ratio of 12.25, significantly greater than its closing ratio on Wednesday. Here’s why.

Quarter Year-over-year revenue growth
Q2 2012 32%
Q3 2012 32%
Q4 2012 40%
Q1 2013 38%
Q2 2013 51%

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