More and more people around the globe are using TripAdvisor to plan their trips. Source: Tripadvisor.
Continue Reading Below
The trickiest thing about risk -- especially when it comes to investing -- is defining it.
Ask yourself: should the possibility of a 10% drop in one day qualify as a risk? In the past two years, shares of Tripadvisor have fallen by at least 10% on two different occasions. Does that make it "risky"? What do you think after considering that shares have gone up by at least 10% on four different occasions in the same timeframe?
I would argue that this isn't risk -- it's just volatility. That's important, because I believe in defining risk as the possibility of losing a significant sum of money over the long run. For now, let's define that as "at least five years."
Given this, I see four main ways to measure the riskiness of Tripadvisor stock.
Balance sheet risk
Nothing makes a company more fragile than debt. If tough times hit and you can't pay the bills, you can either declare bankruptcy or dilute your shareholders. The opposite of debt is cash on hand. If you have ample cash on hand, tough times can actually represent opportunity -- to acquire competitors or buy back stock.
Continue Reading Below
For Tripadvisor, the company's balance sheet is in very good shape. The company has almost $700 million in cash and equivalents, with only $200 million in long-term debt.
Balance Sheet Risk = Low
Customer concentration risk
If you want to see what customer concentration risk looks like, just look at the long list of companies that count on Apple for the majority of their revenue. Any decision made in Cupertino that could go against a supplier could end up bankrupting it.
The same type of risk is true across all industries, and is especially worth noting with Tripadvisor. During 2015, the company counted on Priceline.com and Expedia for a combined 46% of consolidated revenue. That revenue mainly comes in the form of advertising on Tripadvisor's website.
Importantly, Priceline and Tripadvisor reached an agreement this year whereby Tripadvisor visitors can instantly book reservations without leaving Tripadvisor's site, by having access to Priceline's Bookings.com listings.
Though this agreement should make investors feel good about close relations between the two companies, the fact that two customers wield so much control over Tripadvisor's revenue is reason for pause.
Concentration Risk = High
Here's where things really start to get tricky. Tripadvisor the website has a mile-long moat around it. While just about anyone can start a website for travel reviews -- or make an app to do the same -- no one has done it nearly as well as Tripadvisor.
According to the company's most recent earnings release, "user reviews and opinions reached 320 million at December 31, 2015, covering 995,000 hotels and accommodations, 770,000 vacation rentals, 3.8million restaurants and 625,000 attractions."
Tripadvisor benefits from what I consider the most powerful moat: the network effect. With each additional review, more users are drawn to the site, which is additional motivation to list one's company on the site, which draws even further reviews. It's a virtuous cycle.
That means that Tripadvisor's moat for advertising is relatively strong. But the company's future actually lies in Instant Booking. The segment is considered part of click-based advertising -- which is the company's largest revenue stream -- but management doesn't break out how much is from Instant Booking and how much comes from the company's legacy Metasearch feature.
In Instant Booking, Tripadvisor's primary competitors are its biggest customers -- Priceline and Expedia. It's good news that Priceline is playing along for now, as are eight of the top ten hotel chains worldwide. Even though overall advertising revenue is well protected, however, the possibility still remains that competition for Instant Booking revenue will be fierce moving forward.
Competition Risk = Medium.
Finally, we have valuation risk. A company can grow its earnings by leaps and bounds, but still see its shares fall. That's because its stock could have been priced for even greater growth.
Currently, Tripadvisor trades for 31 times non-GAAP earnings and 33 times free cash flow. Those are expensive price tags, though not outrageously so. For comparison's sake, the S&P 500 is trading for about 21 times earnings. But the average S&P 500 company isn't expected to grow earnings by 20% per year over the next five years. In the end, if Tripadvisor fails to address a large swath of the market opportunity through either Instant Bookings or its next venture -- Attractions -- the stock could fall precipitously.
Valuation Risk = Medium
So there you have it: over the next five years, Tripadvisor qualifies as a medium-level risk company. The greatest of those risks come from the potential for frayed relations with Priceline or Expedia. Keep your eye on those relationships, and you'll be watching what will likely matter the most over the next half-decade.
The article How Risky is Tripadvisor Inc Stock? originally appeared on Fool.com.
Brian Stoffel owns shares of Apple and Priceline Group. The Motley Fool owns shares of and recommends Apple, Priceline Group, and TripAdvisor. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.
Copyright 1995 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.