This Just In: Upgrades and Downgrades

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At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

Addicted to Zynga
Judging from media reports, the phenomenon of "video game addiction" is turning into a real scourge of modern society. In 2005, a gamer in South Korea reportedly collapsed and died of organ failure after a marathon 50-hour gaming session. In 2009, a South Korean couple was convicted of negligent homicide for getting so wrapped up in their video games that they allowed their own baby to starve to death. And this week, the Internet gaming fad claimed its latest victim... when analyst Needham & Co. let itself get lured back into upgrading Zynga (Nasdaq: ZNGA  ) .

As you may recall, Needham got spooked out of Zynga last month when the company announced a mammoth $687 million share issuance, threatening to flood the market with Zynga stock. Fearing the stock would crater in response, Needham advised selling the shares -- but you could tell Needham didn't really mean it. Gushing over the Facebook partner's "competitive strengths ... cash-rich balance sheet, and new market opportunities," Needham left no doubt it would jump right back into this stock at the first excuse.

It found that excuse this week.

Noting that Zynga has now fallen 27% since it recommended selling the stock last month, Needham argued that now that the "surge of insider selling" has passed, "risk is now reflected in the shares." Zynga's "strong" prospects, argues the analyst, now justify... well, if not buying the stock aggressively, perhaps, then at least holding on to any shares you managed to pick up during the sell-off.

But is Needham right? Has all the risk really been wrung out of this stock?

Game on for Zynga?
I wish I could say it has, but the truth is quite the opposite. Profitless today, and priced at more than 27 times the earnings it might earn two years from now, Zynga remains one very expensive stock. Here's how the numbers break down:

Zynga isn't currently profitable, and it may never earn the profits that analysts expect it to. Well and good. But there are still ways to value the company: price-to-sales, for example. At more than 6.3 times trailing sales, Zynga bears a valuation more than 50% more expensive than rival gamer Glu Mobile (Nasdaq: GLUU  ) . It's twice as expensive as Activision Blizzard (Nasdaq: ATVI  ) -- which is actually a profitable business -- and nearly five times the cost of Electronic Arts (NYSE: EA  ) , which isn't.

And if you really want to compare apples to watermelons, Zynga's P/S ratio makes the stock look 75% more expensive than Microsoft (Nasdaq: MSFT  ) , which, unlike Zynga, (a) owns its own gaming platform (Xbox) and can produce software tailor-made for it, (b) owns a piece of Zynga's platform, Facebook, and (c) you guessed it, is wildly profitable. Which Zynga isn't. (Or did I mention that already?)

Foolish takeaway
Even if you agree with Needham's argument that Zynga has now become riskless -- and I don't -- the fact remains that there are any number of more attractive investment opportunities out there in the gaming sphere. More profitable companies (Microsoft and Activision), faster growers (Glu), and soon-to-be-profitable, established brands with flush bank accounts and a growing presence in social gaming (EA).

Long story short, there's still a short argument to be made against Zynga.

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Fool contributor Rich Smith owns shares of Activision. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 363 out of more than 180,000 members. The Motley Fool has a disclosure policy.

The Motley Fool owns shares of Microsoft. The Fool owns shares of and has written calls on Activision Blizzard. Motley Fool newsletter services have recommended buying shares of Activision Blizzard and Microsoft. Motley Fool newsletter services have recommended creating a synthetic long position in Activision Blizzard and a bull call spread position in Microsoft.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 20, 2012, at 11:10 AM, steveat wrote:

    You're right, but it's still gonna get hyped and pumped when FB IPO's this month, so buy in when you can and sell like hell leading up to the FB IPO.

  • Report this Comment On April 20, 2012, at 11:22 AM, JPizon wrote:

    blah blah blah, same story different day.

    Once you guys have cross hairs set it does not matter. You remind me of my always right girlfriend, even when she is clearly wrong she will still maintain being right.

    Narrow minded, since I see LOTS of companies with P/E in the 100's (BAC for example)

    It's the potential, and ZNGA has that.

  • Report this Comment On April 20, 2012, at 12:48 PM, rowbz wrote:

    "Zynga isn't currently profitable".

    Is this a joke? Zynga has been profitable since September of 2007. Last quarter they had a one time $510 million employee compensation expense triggered by the IPO; accounting for that, they were profitable, just like they have been for the last 18 quarters. Give me a break!

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