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.

Wall Street comes un-Glu'ed
Shares of mobile-game maker Glu Mobile (NASDAQ: GLUU  ) are taking a tumble in midday trading as investors react to a Northland Securities downgrade (to market perform) ahead of next week's earnings report.

Details on the downgrade aren't widely known at present. (Even our usual inside source, at StreetInsider.com, doesn't seem to know what sparked the downgrade.) What we do know, though, is that Northland, which previously backed Glu stock, has slashed its price target by a third, and now thinks Glu shares are worth only $3. And yet... should this really worry investors?

After all, priced at just $2.40 today, a move to even $3 would equate to a whopping 25% profit for investors who buy today. That's the kind of proverbial "nothing" that investors wouldn't ordinarily sneeze at...

Problem is, "nothing" also pretty much sums up the basis for thinking that Glu shares might be worth $3. I mean, the stock's not profitable, nor is it expected to earn a profit this year. Glu reported losses in excess of $23 million over the past three quarters, while burning through nearly $12 million in negative free cash flow. So while Wall Street analysts, on average, tell us this company is likely to grow its profits at the rate of 30% per year over the next five years, an investor can be forgiven for asking: What profits? And isn't 130% times a loss really just a bigger loss?

A better idea...
When you get right down to it, it's really hard to fault Northland for backing carefully out of its buy position on Glu today, before the numbers have a chance to get even worse next week. But that doesn't mean all gaming stocks should be shunned.

Consider: Glu shares may sell for 2.1 times annual sales, 3.8 times book value, and infinity times the-profits-it-isn't-earning, but you can own a piece of the much better social mobile gamer Zynga (NASDAQ: ZNGA  ) for just 1.7 times sales, and 1.1 times book. Zynga isn't profitable, either. But if you're dead set on owning a money-losing business, at least you should give thought to buying one that costs a bit less.

...and a few more that are even better than that one
Of course, crazy as it may sound, some people actually like investing in profitable companies. For them, here are three more ideas that might hold more appeal:

GameLoft  (NASDAQOTH: GLOFF  )
Priced at just 6.6 times earnings, this France-based mobile gamer has proven that it actually is possible to earn a profit from simple mobile gaming. The company's not listed on a major U.S. stock exchange, but can be bought over-the-counter.

In fact, maybe it should be bought. In addition to earning profits, and sporting an ultralow P/E ratio, GameLoft beats Zynga and Glu both when it comes to its price-to-sales ratio (0.6) and its price-to-book as well (0.9). Best of all, GameLoft boasts annual free cash flow of $23.5 million, which is even more than it reports as GAAP net income.

Electronic Arts and Activision (NASDAQ: ATVI  )
No article on video gaming would be complete without at least mentioning the two giants of the world. Neither EA nor Activision gets much respect these days, in this world where all the talk is of mobile, social, and usually unprofitable game making. But for traditional investors, there's still a lot to like in these companies.

Each is incredibly cash-profitable, generating far more free cash flow (cash profits) than it reports as net income. Of the two, Activision still earns my vote as the top value in big gaming, based on its low P/E (at 14.9, only half the price of a share of EA), its even lower price-to-free cash flow ratio (just 11.2), its steady-eddy growth rate of 9%, and its modest 1.6% dividend yield.

Throw in an "Easter Egg" in the form of a balance sheet brimming with $3.4 billion cash, and not a drop of debt, and I still think Activision is your best bet in gaming stocks todaya... although to be totally honest, after running all these numbers, I'm going to have to go back and take a much closer look at GameLoft as well.

2013 and beyond
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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 February 04, 2013, at 11:52 AM, thesand wrote:

    the timing of downgrade is a dirty game from the them,last year the evaluation was in 02-14-2012 ,that mean the evaluation should mean nothing to any one because it stand for zero information

  • Report this Comment On February 05, 2013, at 3:02 PM, thesand wrote:

    non of the kids in the market can determine what is going on with gluu ,im surprise who is leading the stock down buy selling 100 stock every couple min.,the company in a good position and worth the money you spend ,at least it has no debt ,the gaming market is going up , the mobile business is higher than before,the company need to control the expense little bit to be positive in the future,the revenue is very good now,the company who did the downgrade was a revenge fro insider who is buying the stock,idont know what type of information they have the stock holder doesnt have ,somthing wired.

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