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This Just In: Upgrades and Downgrades

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.

And speaking of the worst...
It's been a rough couple of weeks for investors in the mobile gaming industry lately. On Monday, Zynga (Nasdaq: ZNGA  ) followed up on its bleak Q3 forecast by announcing a plan to lay off 5% of its workforce, and "sunset" 13 of its mobile and social games. Adding insult to injury, the bad news for Zynga failed to dent investor enthusiasm for its main partner in games distribution, Facebook (Nasdaq: FB  ) , which turned a report of robust growth in mobile advertising into about a 20% gain in market cap yesterday.

Now comes the snapback from Wall Street, as it begins to ratchet down expectations for the rest of the industry as well. The first casualty, it appears, is rival mobile gamer Glu Mobile (Nasdaq: GLUU  ) . As recently as a week ago, Glu was on the move as it received a buy endorsement and a $5 price target from ace software analyst Stifel Nicolaus. But just yesterday, another fan of the company -- National Securities -- announced it was walking back expectations.

Downgrading the stock from buy to just "accumulate" -- a rating some analysts will tell you means "buy less," while others will confide actually means just "hold" -- NatSec cut its 12-month target for Glu shares to just $3.96. And while this still leaves some room for upside, the analyst's new rating is more than 20% short of Stifel's estimation, and about 35% below what NatSec previously estimated for Glu's true worth.

What, then, are investors to make of the new rating? Should you buy the stock and hope for NatSec's promised 17.5% profit? Should you stick tight with Glu, because after all, the analysts' ratings do seem to endorse it? Or should you...

...sell Glu Mobile?
Actually, I think the best play here may be to get ahead of the analysts as they begin turning more negative on Glu. Take a look at the numbers, and starting thinking about what could go wrong.

Consider that, no matter what analysts say about how Glu shares might perform in the future, one thing's for certain: Right now, today, Glu really isn't that great of a business. Over the last 12 months, Glu has managed to lose $26 million. The company's cash flow statement shows that things aren't quite as bad as GAAP makes them look, but even so, the company's $9.2 million in trailing negative free cash flow still isn't great news for investors.

Worse, projections for the upcoming earnings release (due out Nov. 1) suggest we could be looking at a GAAP loss of as much as $0.06 per share at Glu -- three times the damage incurred in last year's Q3. In short, if Glu shares have underperformed the S&P 500 by more than five percentage points over the past year, they've done so for a reason. So far, Glu's business just doesn't seem all that sticky.

A better idea
Fortunately, though, in a world populated with 10,000 stocks, even if companies like Zynga and Glu don't work out, investors still have a wealth of alternatives to invest in. Electronic Arts (Nasdaq: EA  ) , for example, may not look like much of a bargain at 74 times earnings. But at least it has earnings (something Glu can't say about itself). And EA generates more than twice as much free cash flow as it reports as GAAP net income.

At an enterprise value of 23 times annual free cash flow, I won't say EA is the cheapest stock on the planet. But with earnings projected to grow at almost 17% per year over the next five years, it's not the most expensive, either.

Activision Blizzard (Nasdaq: ATVI  ) , meanwhile, remains a powerhouse in computer gaming. Its enterprise value-to-free-cash-flow ratio is about 8.6 -- a veritable bargain price, considering that most analysts expect Activision to grow its profits at a better-than-10% annual rate over the next half decade.

Perhaps best of all, the stock pays shareholders a tidy 1.6% dividend for their patience as they wait for Mr. Market to wake up from his faddish infatuation will all things mobile, and discover that yes, Virginia, there are profitable gaming companies you can invest in.

The mobile revolution is still in its infancy, but with so many different companies it can be daunting to know how to profit in the space. Fortunately, The Motley Fool has just released a free report on mobile named "The Next Trillion-Dollar Revolution" that tells you how. Inside the report, we not only describe why this seismic shift will dwarf any other technology revolution seen before it, but we also name the company at the forefront of the trend. Hundreds of thousands have requested access to previous reports, and you can access this new report today by clicking here -- it's free.

Read/Post Comments (3) | Recommend This Article (1)

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 October 27, 2012, at 4:05 PM, GrandSlammer wrote:

    Skate where the puck is going, not where it has been! GLUU might still make losses today, but the trend speaks for itself. Their new business model with 100% focus on mobile gaming is highly successful and their games are very popular. Just check the latest rankings in the app stores

    At current levels, gluu is a great buy

  • Report this Comment On October 27, 2012, at 4:39 PM, TMFDitty wrote:

    I suppose it depends on what trend you are looking at.

    I, for one, see no trend in revenues, which are up one year, down the next, and currently back at 2009 levels. The trend in losses is up, and in cash burn, nearly as bad.

    Popular games without profit makes Glu a wonderful gamesmaker, but a poor investment.

  • Report this Comment On October 28, 2012, at 12:21 PM, GrandSlammer wrote:

    If you go back to Q1 2010, some 12% of GLUU's revenue came from smartphone games, the rest from old feature phone games. Revenues in that quarter were USD 17.2m. Ever since, management has been agressively driving the shift towards smartphone and tablet games while simultaneously phasing out the feature phone business. this had initially a negative effect on sales but if you go through all the interim reports, the smartphone revenues have been growing steadily in ever single quarter. in q2 2012, the smartphone business stood for 84% of revenues, which were by the way USD 23.6m. maybe you start seeing a trend now?

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