I'm Buying This Hated Stock

On Monday, I offered up three "hated" candidates I was considering buying. I say "hated" because our CAPS community rated all three candidates as one-star investments. Sometimes -- as I showed -- it pays to swim against the current.

On Monday, I focused on the potential upside of all three companies; today, I'm acknowledging the risks associated with them and calling out the one selection that my money will be behind.

Avoiding Chinese small caps
Though it's not the only reason I'll be avoiding Dangdang (NYS: DANG) , I promised myself at the outset of the year that I wouldn't be buying into any Chinese small-cap companies. And with a market cap of just $500 million, Dangdang definitely falls into that category.

But let's ignore that for the moment and focus on other risks. It takes time to be profitable in online retail. The process of building out fulfillment centers and offering products for razor-thin margins only works if you've become the dominant player in e-tailing.

Sadly, Dangdang is at a disadvantage. Right now, Taobao owns 49% of the market share in China, and 360buy.com owns another 18% of it. It will be very tough to expand with these two players having already established a formidable presence.

In the end, though, I'm not worried. If Dangdang becomes the e-tailer in China, it will grow to be many hundreds of times bigger than it is today, and I can pick up shares later, when there's less risk involved.

A doomed business model?
In my initial write-up, I focused on how Pandora (NYS: P) was disrupting the business plans of radio leader Sirius XM (NAS: SIRI) . I'm a big fan of Pandora's Music Genome Project and its ability to create personalized listening stations, and Pandora is quickly encroaching on Sirius' presence in automobiles.

There's a catch, though: By focusing primarily on revenue through advertisements, the business may simply not be sustainable. Through the first three quarters of 2011, revenue from advertising made up 87% of all revenue. When you consider the fact that mobile streaming is likely the future of Internet radio, and that mobile advertising will likely generate less revenue than ads streamed through to a computer, you see problems starting to form.

But even more alarming is this: Pandora's content acquisition costs. That's really a fancy way of saying that the company has to pay royalties for every hour of radio that users listen to. Right now, those payments eat up a whopping 52% of revenue.

While the number of hours of streaming grew by 120% during the first three months of 2011, the number of active users grew by just 38%. That's a huge problem when you have to pay royalties for all those hours but can only show potential advertisers that your customer base has grown by a much smaller margin.

But if any stat tells me to stay away from this company for now, it's this: Royalty payments are increasing faster than revenue. While revenue during the third quarter went up by 99%, royalty payments ballooned by 107%.

It's time for me to link in
That means that as soon as trading rules allow, I'll be putting my money -- and my All-Star CAPS profile -- behind business networking site LinkedIn (NYS: LNKD) . Yes, the company currently trades at 824 times earnings, but a wise man once offered sage advice about sky-high P/Es: They're the result of either a company just starting to be profitable or a company that the market rightly respects for its execution and potential. For LinkedIn, I think both are the case.

The company's three streams of revenue are all showing promising growth.

 Revenue Stream

Q4 2011 Rev. Growth

Percent of All Rev.

Hiring Solutions

136%

50%

Market Solutions

77%

30%

Premium Subscriptions

87%

20%

Source: SEC filings.

With its promising new venture on the way -- Talent Pipeline -- that promises to help streamline and disrupt the human resources field, I wouldn't be surprised to see these trends continue.

And while I like the company's multiple streams of growing revenue, as well as the snowballing of its network effect -- it now has 150 million registered users -- international growth also gives investors reason to be excited.

Currently, international revenue represents just 33% of total revenue. Don't be surprised to see that number surge in the near future. The company has opened up offices in Japan, India, and Brazil, and its website will soon be available in Japanese, Swedish, Indonesian, Malay, and Korean.

With trends like that in its favor, I have no problem throwing money behind LinkedIn.

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At the time this article was published Fool contributor Brian Stoffel does not own shares in any of the companies mentioned. He will be buying shares of LinkedIn when trading rules allow. You can follow him on Twitter at @TMFStoffel.The Motley Fool owns shares of LinkedIn. Motley Fool newsletter services have recommended buying shares of LinkedIn. 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.

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