April 4, 2013

Finding Value in the Growing Online Advertising Industry

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By Justin Kuepper · Wednesday, April 3rd, 2013

There’s little question that the online advertising industry is rapidly growing. Advertisers looking for a better return on investment are increasingly moving from untargeted television or newspaper ads to highly targeted online ads. In fact, IDC expects online advertising to account for 20.6% of all ads in the U.S. and reach $67.4 billion in size by 2016, which is a dramatic improvement over 14.0% of advertisements and a $35.5 billion market size in 2011.

Unfortunately, the sector’s rapid growth has made it difficult for investors to find undervalued opportunities in the space by just about any measure. According to Morningstar, the online advertising industry trades with an average price-earnings ratio of 28.2x compared to the S&P 500’s 16.2x price-earnings ratio. These numbers suggest that the average online advertising stocks may be as much as 74% more expensive than the average U.S. stock.

Many companies are also overpriced when looking at their historical valuations. For example, ValueClick Inc. (NASDAQ: VCLK) trades with a price-earnings ratio of 23.6x that suggests its more than 107% overpriced relative to its 5-year average price-earnings multiple of 11.4x. Google Inc. (NASDAQ: GOOG) is in a similar situation, trading with a 25.1x price-earnings multiple that is 5% higher than its 5-year average 23.9x price-earnings multiple.

Finding Value in Online Advertising

Higher growth rates may justify higher valuations in some cases, since investors should clearly be willing to pay more now for more potential earnings later. But, anticipated growth rates are highly subjective and the market likes to change its mind frequently. Most investors may be better off identifying undervalued companies that are experiencing strong growth rates AND trading at a discount using measures like price-earnings and price-book.

Yahoo Inc. (NASDAQ: YHOO) is perhaps the most well known example of an undervalued stock in the online advertising industry. With a price-earnings ratio of just 7.1x, the stock is 75% cheaper than the average online advertising company and 56% cheaper than the S&P 500. A price-book ratio of just 1.8x also suggests that investors are purchasing the stock closer to the value of its assets (e.g. the liquidation value) than many other online advertising stocks.

CrowdGather Remains a Great Option

CrowdGather Inc. (OTCQB: CRWG), however, is perhaps one of the best examples of an undervalued online advertising company. With a price-book value of just 0.3x and a price-sales ratio of 1.9x, the company appears significantly undervalued compared to industry averages of 4.0x and 5.8x, respectively. Moreover, the low price-book value suggests that investors can acquire the stock for less than the company’s estimated liquidation value.

While the company is losing money on a net income basis and intends to raise additional capital, the financing represents an investment in its operations and will enable it to execute on its growth strategy. More importantly, insiders have expressed a lot of confidence in these future plans, with CEO Sanjay Sabnani making open market purchases and institutional investors holding a significant stake despite the stock’s relatively small market capitalization.

In the end, investors can purchase CrowdGather for 67% cheaper than the average online advertising company on a price-sales basis, while strong institutional and insider ownership instills confidence in its long-term strategy and market opportunity.




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