This Just In: GrubHub Inc. Gets Started at "Buy"

By Markets Fool.com

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." So you might think we'd be the last people to give virtual ink to such "news." And we would be -- if that were all we were doing.

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But in "This Just In," we don't simply tell you what the analysts said. We'll also show you whether they know what they're talking about. To help, we've enlisted Motley Fool CAPS, our supercomputer tool for rating stocks and analysts alike. With CAPS, we track the long-term performance of Wall Street's best and brightest -- and its worst and sorriest, too.


Source: GrubHub.

And speaking of the best ...
On Friday, just ahead of the holiday weekend, one of the best analysts out there issued a new "buy" recommendation. Initiating coverage on GrubHub , the one-stop online service for ordering restaurant take-out, ace stock shop Stifel Nicolaus recommended investors buy it.

Says Stifel, GrubHub is "one of the most compelling small- to mid-cap companies in the Internet sector today." The analyst posits "$8B-$10B" as the potential size of the online takeout food market. But in Stifel's view, this is not a market where share will be evenly distributed among multiple companies. Rather, whoever is first to develop a loyal following online will become the "winner-take-most" in market share.

Right now, that winner looks like GrubHub. And as Stifel sees this business offering high profit margins but requiring little capital investment -- a good recipe for high profits growth -- it thinks GrubHub's "26x multiple" to 2016 estimated earnings is more than justified. Indeed, if you ask Stifel, this $37 stock could easily be worth $46 a year from now.

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But is Stifel right about that?

Let's go to the tape
With a record of 52.5% accuracy on its picks, and nearly 9% outperformance of the market per pick, Stifel Nicolaus is one of the better stock pickers we follow on CAPS. Among Internet Software and Services stocks, Stifel's winners have significantly outperformed its losers, outperforming the market by a combined 732 percentage point over nine years and 40 separate picks. A few examples:

Company

Stifel Nicolaus Said:

CAPS Says (Out of 5 Stars Possible):

Stifel Nicolaus' Picks Beating (Lagging) S&P By:

MercadoLibre

Outperform

****

125 points (Picked once to outperform, once to underperform -- and right both times)

eBay

Outperform

****

8 points (right 3 out of 4 times)

Open Text

Outperform

*****

(14 points)

Twitter

Outperform

**

(51 points)

Source: Motley Fool CAPS.

So what are the chances that GrubHub will end up in Stifel Nicolaus' "wins" column a few years from now?

The valuation proposition
I admit that, at its current valuation of 198 times earnings, GrubHub shares seem very rich fare indeed. But from at least one perspective, Stifel's decision to endorse this highflyer make sense.

Consider: Valued on free cash flow (the cash profits the company produces, as opposed to the "accounting earnings" it reports), GrubHub shares sell for about 48.5 times FCF.

Ordinarily, this would be a valuation that scares me almost as much as the stock's 198 P/E ratio. However, analysts who follow the stock (and there are five of them, according to S&P Capital IQ) generally agree that GrubHub is at an early stage in its growth game and will probably average profits growth of 55% annually over the next five years.

Such a rapid rate of growth is actually fast enough that it could justify the stock's sub-50 P/FCF ratio. What's more, given that GrubHub has grown its revenues nearly four-fold over the past three years, there's every reason to believe this 55% growth rate is attainable.

Meanwhile, the company boasts a strong balance sheet, featuring $278 million in cash, and not a lick of debt. That strong cash position, combined with GrubHub's modest capital requirements (capex over the past year, for example, was a mere $4 million), helps to ensure the company will have time to recover from any stumbles it might encounter en route to its anticipated growth, and not run out of cash while trying to find its footing.

First come, first served
Long story short, while I'm not ordinarily a fan of investing in recent IPOs bearing high P/E ratios, GrubHub appears to be an exception to the rule. The analyst backing it has a record as good as GrubHub's own. And if future growth pans out as expected, this stock could make for a very tasty investment indeed.

The article This Just In: GrubHub Inc. Gets Started at "Buy" originally appeared on Fool.com.

Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 271 out of more than 75,000 rated members.The Motley Fool recommends and owns shares of eBay, OpenText, and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.