Spark Networks (AMEX: LOV) owns a variety of dating websites catered to specific groups, including JDate.com, BlackSingles.com and ChristianMingle.com. At first glance, the stock has all the makings of a potential value play. It's got captive audiences in a growing industry, a P/E under 10, and its net income has grown consistently as follows:
Looks great! Unfortunately, this is exactly why investors cannot make purchase decisions "at first glance". We've discussed examples here of what kinds of things get buried in the notes to the financial statements. In this case, however, the investor need not go further than the income statement. Take a look at the following line items from the 2007 and 2006 Income Statements:
While most companies lose 35-40% of their income to tax, Spark Networks actually gets to double its income in 2007, and pay very little tax in 2006! Clearly, this is not sustainable. A careful reading of the notes reveals this tax gain is a result of making up for past operating losses, and that a large chunk of these tax assets have now been used up.
Applying a normal tax rate to the 2007 before-tax income would suggest a trailing P/E of around 30, rather than the appetizing 9 currently displayed by your favourite stock screen. Does this mean Spark Networks is overvalued? Not necessarily, but as value investors we like to buy companies that consistently make money and sell at discounts to their intrinsic values, and LOV hasn't proven it measures up to either of these criteria.