(07/11/13) Phone Books Go Digital with Yelp

Yelp is the hands-down leader in local advertising content and viewership, and thus, is the odds-on favorite to win as this market goes increasingly digital, says Timothy Lutts of Cabot Stock of the Month.

Earlier this month, I was in Washington DC at a conference, and one night I found myself with a group of colleagues at a very popular restaurant, where we were told the wait would be 30 minutes.

So I stepped outside, opened the Yelp (YELP) application on my iPhone, and quickly found a perfect substitute just a block away that was not only less crowded but less expensive as well. When it comes to finding local businesses, Yelp is unbeatable.

Then, back home in Salem, Mass., someone drove by in a car and threw a Yellow Pages book on my front step. I threw it right in the recycling bin. In short, I've made the switch.

With Google and Yelp and other specialized apps at my fingertips, there's no reason to use the Yellow Pages anymore. Yet the Yellow Pages is still a $6.9 billion market in the US and a $16 billion market globally!

Eventually, that business—along with coupons and flyers—will dry up as we all go digital, and Yelp is likely to be a major beneficiary.

Yelp launched its business in San Francisco in 2004, creating its name by combining and shortening the words "Yellow Pages."

The San Francisco market is now mature but still growing, and every market the company has entered since then—Yelp is currently in 97 markets in the US, Canada, Europe and Australia—has followed the same growth trajectory, though somewhat faster.

In short, growth is predictable—and that growth is not slow! The group of markets launched in 2005-2006, for example, grew 59% last year!

For revenues, Yelp depends on advertising, of course. Local advertising currently accounts for 70% of revenues, while brand advertising accounts for 21%, with the remainder coming from other services. And there are still many more advertisers to attract.

In fact, of the estimated 53 million local businesses in the firm's targeted regions, only 1.1 million have claimed their Yelp sites and just 45,500 are advertising on Yelp. So the growth potential for the company, which has no debt, is still huge.

And as more business get listed, they will attract more Yelp users who become business patrons—one study showed that just having a decent presence on Yelp can boost sales by about $8,000, with that number tripling if it's combined with marketing efforts.

And as more of these users write anonymous reviews for businesses, their presence on the site will attract more advertisers, creating a self-reinforcing cycle similar to the one that once made giving away fat yellow phone books a profitable venture.

But you can't take a fat phone book with you when you leave the house, and with 45% of Yelp activity now on mobile devices, the future is clear.

Yelp's revenue growth rates are very healthy and cash flow is positive. Expansion activity has kept earnings in the red so far, but that should change in the quarters ahead: analysts are estimating earnings will hit $0.16 per share in 2014.

Yelp went public on March 2, 2012, at $15, climbed to $24.5 on its first day of trading, and hit $32 a month later. But it then cooled down, and didn't exceed that old peak until early last month, when an excellent earnings report sparked big-volume buying that gapped the stock up to $32.

The stock has broken out to new highs above $37 for one simple reason: more and more investors are becoming aware of this young company and its potential to get much, much higher. If you don't own it yet, you can buy on this breakout, and if you do own it, you can buy a little more..