-1) like hell do those results not look gruesome – the revenue has flatlined.

0) If you have a supposed “growth” company that ain’t growing sequentially for two consecutive reporting periods, then this is not a minor tweak to the DCF – it’s a totally broken investment thesis.

1) Volatility hurts higher-beta companies a lot more than low-beta ones. And given the disastrous performance of the IPO, this one was never going to suddenly go up a lot in a bear market

2) This is basically you betting ideology against reality; post-2000 we can all agree that the IPO valuations of technology companies with restricted free floats are not efficient prices. The restricted free float is very important here – if anyone had ever tried to float the whole of Groupon it would never have got that “market capitalisation” in the first place.

3) Priceline has earnings, and could probably pay a dividend if it wanted to. It was never going to fall as far or as fast as Groupon, so there really wasn’t a winning draw this way.

I think what this proves is that as you say, stocks are different from bonds (although actually I suspect that you could have constructed a similar bet on the credit and got similarly hosed).

The greater problem with Groupon is that there has never been a clear path to profitability. The business model gives too much away to the consumer, leaving too little for the merchant and Groupon to split profitably.

If Groupon had managed to turn even a small profit, they might have “only” fallen 50%.

(1) Low barrier of entry. I had already purchased one or two “Groupon”, but from a competitor, not from the original. Didn’t/don’t see any reason to prefer Groupon to an upstart.

(2) Very high cost of acquiring customers, much higher than the likely profitability of said customers. That is a business model with a negative ROI.

(3) A business model with merchants that has limited applicability, low likelihood of repeat business. Surely there aren’t many businesses that can regularly give away their product at a 75% discount (and any that makes a habit of doing so will encourage regular customers to seek the discounts).

(4) Essentially zero profits. Ever. I’m not arguing that net income trumps all other measures, but an unprofitable business is not a good investment.

I agree that you have no business investing in stocks if you couldn’t see a year ago that Groupon was a HORRIBLE investment. But I strongly disagree when you say that the market is unpredictable. Over time, price tracks earnings. (Or more to the point, price tracks the projected earnings a few years into the future. Thus the volatility when the trend shifts.)

I think you mean, this is why you’re not a successful fund manager, trader or analyst.

“It’s impossible to know what kind of future growth rate is priced in to a stock, and it’s even more impossible to have a good grasp of what a company’s future growth will be”

Sure, you can’t know (legally) with 100% certainty but without institutional bias and with proper research, diligence, analysis, and a keen knowledge/appreciation for history, you can often get close. It isn’t pure luck (although a little luck never hurts) that our pick/pan performance absolutely destroys that of most analysts and funds.

You are correct though that DCF-style valuation (as well as other methods) is sensitive to even small tweaks to the inputs/drivers, but that is why we do sensitivity analysis and use that information to using prudent risk management based thereupon (e.g. having stops/limits in place). Of course since this was a bet, not a trade, you’d have to just alter the terms of the bet, but that’s neither here nor there.

I like that you’re willing to stick your neck out and make these bets public and write about the results in hindsight. That’s why our site says “Those who fail to learn from history are doomed to repeat it,” so it’s good to see you’re doing this sort of post-mortem evaluation of what happened.

Jordan S. Terry
Managing Director
Stone Street Advisors LLC

You know what the best part about stocks is. When your entry point timing stinks but your thesis is sound you get the opportunity to double down. Be a player and go long a couple grand worth of GRPN and short a couple grand of Priceline.

If you think GRPN is likely to grow then you’re in good shape.

The one question I have for you is your use of the world “mistrustful.” That’s a pretty loaded word. It almost implies something sinister. I agree 100% with you that the market needs no reason to change the P/E on a stock from 15 to 10 the day after you buy something. You just can’t count on the short term “voting” function. What you can absolutely can count on is the longterm weighing function. If a company is growing sales and earnings then sleep well knowing that the value of your share is rising irregardless of the price you see on your screen.

You shouldn’t be any more mistrustful of the stock market than you are of the weather. Both are entirely unpredictable in the short term and entirely predictable in the longterm.

As for this point from Felix – “the kind of things which hurt one bubbly tech stock tend to hurt them all” – it completely misses the fact that Groupon and Priceline are very different animals. Priceline generated $1.2 billion in net income for the latest reported twelve months (ended Sept. 30, 2012). Trading at $625, the trailing P/E is 24x and forward P/E is 17x. Latest quarter y-o-y revenue growth was 17% and y-o-y earnings growth was 27%. It’s a solidly profitable company growing at a nice rate. In both 2009 and 2010 net income was roughly $500 million, with some growth from 2009 to 2010, but then a huge leap to current performance levels in 2011. I don’t know enough about Priceline to know the underlying cause of this growth, but the point stands that Priceline has been solidly profitable for several years.

Groupon, on the other hand, has the financial issues that dmcdougall points out. Basically, buying Groupon stock is making a wager that it can grow revenue and leverage expenses such that its earnings look something like Priceline’s in 3 to 5 years. No surprise that the stock craters as that possibility looks less likely.

Buyers expected that Groupon was well positioned to turn early exponential user growth into either profitability or continued revenue growth; this has turned out, so far, to be untrue on both counts. Any high growth firms needs to shift from growth to profitability at some point, but Groupon’s post-IPO performance has been a shift from growth to an unprofitable revenue plateau. For a company whose value prices in either growth or profitability, the absence of both is a good reason for a share price collapse.