Investors love companies with a compelling story of growth potential, because these stocks can deliver big-time profits as the thesis plays out. But not all story stocks live up to the hype. Sometimes the numbers just don't match the story, while other times a company's management team can be squandering its opportunity. That's why investors need to take a step back and make sure a company's performance matches its expectations.
With this potential pitfall of getting caught up in the hype in mind, our contributors took a critical look at three story stocks: Electronic Arts (NASDAQ:EA), DryShips (NASDAQ:DRYS), and Snap (NYSE:SNAP). Only one of the companies seems to be living up to all the hype, in our opinion.
Take a picture; it'll last longer
Rich Duprey (Snap): Although a lot of the ebullience is gone from social-media platform Snap following its IPO three months ago, its stock continues to bounce back as investors keep hoping it will find the magic formula to succeed. You'll do your portfolio a solid if you just stay away from Snap altogether.
Even at a price that's 27% below the high it hit out of the gate, it's still vastly overvalued. Its $25 billion market cap means the market is willing to pay 50 times sales for a company that's producing losses north of half a billion dollars. User growth continues to fail to impress, it's been forced to offering discounts to attract advertisers, and there's still no effective counter to competition from Facebook (NASDAQ:FB) and its own photo-sharing site, Instagram.
In its first-quarter earnings report last month that many had been watching to see what direction it would be heading, user growth was up 36% year over year, a not too bad result on the surface, but just another indication that growth was decelerating. Snap reported 48% growth in the fourth quarter and 63% growth in the third quarter. In fact, a year ago Snap's user growth rate was almost 53%. It's clear it will plateau sooner rather than later.
Snap also can't decide what it wants to be. Its decision to rebrand itself as a camera company, and to buy drone company Ctrl Me Robotics -- not to mention its Snap Spectacles eyeglasses -- ought to be a caution to investors that it's confused about where it wants to go. As if Instagram and WhatsApp are enough competition, it will be going up against bigger and better financed companies, such as GoPro.
There's still way too much hype attached to Snap's stock and investors would do well to ignore it.
This stock can't keep sinking, right?
Matt DiLallo (DryShips): Diversified ocean-going cargo shipper DryShips is one of the most-hyped stocks around these days. Fueling that enthusiasm is its current penny-stock-like price, which traders see as their ticket to big-time profits as the company turns itself around. It's a turnaround that certainly makes sense now that company has shored up its balance sheet, which should enable it to take advantage of the recent rebound in shipping rates.
But while DryShips is a compelling turnaround story, it also has one fatal flaw: Its management team chose to take advantage of investor enthusiasm and flood the market with new equity, which it used to rebuild its decimated fleet as quickly as possible. In total, the company raised $570 million in cash this year to buy 17 new vessels. While those ships have the potential to deliver $77 million in annualized earnings if shipping rates hold up, which could completely reverse its recent string of losses, investors paid a tremendous price in the form of dilution.
For example, during the first quarter, the company had an average of 15.5 million shares outstanding, and it ended the period with 67.4 million shares. That is a breathtaking increase from the year-ago period when it had just 13,901 shares outstanding after taking into account the impact of a cumulative 1-for-48,000 in reverse splits it had completed over the past year. That's an overwhelming amount of dilution for investors and is the main reason the stock is down 99% since the start of the year.
While many investors think the stock has nowhere to go but higher, that dilution could continue to act as a weight for quite some time. Further, given that the company has proved time and again that its primary focus isn't on creating value for investors but instead on using them to line the pockets of its CEO, more dilution could be on the way. That's why investors shouldn't listen to the hype that DryShips could turn a small investment into a big-time profit. It has historically done nothing but obliterate value.
Gamers for life
Daniel Miller (Electronic Arts): If you grew up playing video games, you're familiar with Electronic Arts (NASDAQ:EA). In fact, if you favored sports games, you can probably still hear the "EA Sports" intro ringing in your head. Investors who jumped on board the EA bandwagon half a decade ago have been heavily rewarded.
But after such rapid growth over the past five years, should you still buy into the hype? I say yes.
There are a few trends that bode well for EA going forward. The gaming world is growing, both in its player base and in terms of consumer revenue. EA estimates that the gaming global market forecast will jump from $75.9 billion in 2014 to $96.6 billion during the 2018 calendar year. Further, top titles are driving greater share -- in other words, big blockbuster games are bigger than ever -- and fewer companies are generating those blockbusters. EA is well positioned to benefit from the consolidating trend.
But EA is so much more than it used to be. While it still dominates sports games, which is great because those games come out with new iterations each year and drive recurring revenue, it has branched out into mobile games as well. Going forward in the digital world, there are even more ways for EA to generate incremental revenue and engagement. Consider "The Vault," a subscription engagement model for EA, which would let players subscribe to play a list of titles in the vault as much as they wanted, with more titles being added over time.
We're also approaching a point when e-sports, or competitive video-gaming, is starting to find its way onto television sets. If management can continue to develop blockbusters, branch out further with mobile gaming, and capitalize on the growing e-sports trend, buying into the hype is a no-brainer.