A new report indicates that as many as 20 percent of the reviews on the fast-growing local venues ratings website may be fake.
The report by assistant professors at Harvard Business School and Boston University -- Fake It Till You Make It: Reputation, Competition, and Yelp Review Fraud -- claims that roughly one in every five reviews on the site is fraudulent. Yelp has parameters in place to try an catch these bogus critiques, but obviously it can't catch them all.
The report's authors show that the number of fake reviews -- both positive and negative -- on the site have grown from 5 percent in 2006 to 20 percent in 2013. But while the problem is getting worse, it's something that shareholders may be ignoring. After all, Yelp has been one of the market's hottest stocks in recent months after having more than quadrupled since bottoming out in November.
Will the gains continue if the reviews can't be trusted?
A Cry for Yelp
To its credit, Yelp is doing its best to curb the phonies. It filters reviews that it deems as questionable, and, as you can probably expect, these critiques are usually the only review submitted by a user and typically at the high- or low-end of the five-star rating range.
The most commonly filtered review actually gives the maximum five stars. On the site itself, the most common published rating is four stars. That makes sense. A great experience is extremely rare -- even an outstanding experience at a French bistro or a spa will have some discernible flaws.
By populating its site with legitimate reviews -- and there are now 42.5 million rants and raves on Yelp -- the goal is that sheer volume will help weed out the business owners that try to boost their ratings or diss the competition by creating false reviews.
There's plenty at stake. Michael Luca, one of the two authors of the report, suggests that something as simple as a one-star rating increase in a Yelp profile can contribute a 5 percent to 9 percent increase in business.
Table for Wan
Yelp continues to grow at a healthy clip. There are now 51,400 local business that are considered active -- paying Yelp for enhanced promotional features -- and that's a 62 percent spike over the past year. It clocked in with an average of roughly 108 million monthly unique visitors to its website, 38 percent ahead of last year. And those 42.5 million cumulative reviews are an encouraging 41 percent boost over the past year.
That's great, but Yelp is surprisingly still not profitable.
Analysts see Yelp finally turning a profit next year, but one has to wonder if that will be challenged if the percentage of bogus reviews continues to grow on the site. Credibility's key in this business, and that's why there seems to be more trust on Angie's List (ANGI), where users actually have to pay to be a part of the vetted referrals site.
We also can't dismiss the threat of Facebook (FB). The social networking giant introduced graph search earlier this year, allowing the site's more than 1 billion users to seamlessly search for suggestions from people whom they already know and likely trust.
Google (GOOG) has also been trying to tie its success with Android and Google Maps with its fledgling Google+ social network. If the search giant's products become more social -- and the reviews being collected can be stitched together with Google Places, Google+, and Google Maps -- Big G could prove to be as formidable a potential foe as Facebook.
This brings us back to Yelp's stock trading at unsustainable levels for a company that remains profitless and one whose content credibility is coming under attack.
This isn't the first time that Yelp's model has come under fire. Some merchants argued that they were being shunned for refusing to become paying customers. Yelp rose above the claims, but with Yelp's stock priced for perfection, there is little margin for error here.
Investors giving the stock five-star reviews better be careful before their money gets filtered out.
Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook and Google. Try any of our newsletter services free for 30 days.