Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Well, would you look at that! Everything old is new again -- even Zynga (ZNGA +0.00%)!
Once upon a time, mobile game maker Zynga was popular among investors who wanted to own Facebook but couldn't because Facebook wasn't public yet. As a company that made games played on Facebook, however, Zynga was viewed as a way to vicariously profit from the growth of the social network.
Of course, Facebook did eventually IPO, and when that happened, Zynga's popularity as a stock investment quickly faded. It's back today, however -- up 42% over the past 12 months -- and according to one analyst, Zynga is ready to run even higher.
Here's what you need to know.
Image source: Getty Images.
Zynga's faithful friend
For nearly eight years, investment banker Wedbush has been a staunch defender of Zynga stock. According to data from StreetInsider.com, Wedbush first initiated coverage with an outperform rating way back in December 2011 (predicting the stock would soon go to $12.50 a share -- it costs $5.75 per share today, by the way). At the time, the analyst cited the company's "very popular and durable games of the highest quality" and its "dominant market share among social game publishers" as its reasons for optimism.
Over the years, Wedbush's short-term views of Zynga and its price targets have waxed and waned with the company's fortunes -- but the analyst never quite gave up on Zynga. Never downgraded the stock even once.
Of course, the downside to that steady optimism is that it makes it a bit harder than usual for Wedbush to express increased optimism about Zynga, it being rated outperform already and all. But this morning, Wedbush did the next best thing.
Doubling down on Zynga
Reiterating its outperform rating on Zynga today, Wedbush upped its conviction by adding it to the analyst's "Best Ideas List."
Zynga is currently GAAP-unprofitable, having lost money in three of the last four quarters. It's growing sales briskly, however -- sales were up 41% year over year in the most recent quarter -- and most analysts agree that the company is likely to end the year with at least a small GAAP profit of $0.02 per share, which would be flat against last year's earnings, according to data from S&P Global Market Intelligence.
That analyst earnings estimate gives Zynga a current-year P/E ratio of 287.5 (it has no trailing earnings to hang a P/E on). At first glance, that seems kind of pricey given that most folks on Wall Street believe the company will only grow earnings at about 15% annually over the next five years.
But Wedbush isn't entirely convinced that the rest of Wall Street is right about that growth rate.
"We think that key titles Empires & Puzzles and Merge Dragons!, along with three new releases later this year (and additional new games thereafter), have the potential to drive significant upside to the Street's expectations through 2021," argues Wedbush. And if that's true, Zynga could exceed the $0.02 per share that it's expected to earn this year, bringing its current-year P/E down from 287.5 to something a bit more palatable.
The upshot for investors
Is Wedbush right about Zynga, and the rest of Wall Street wrong?
Only time will tell for sure. However, given that sales are rising so strongly -- again, they were up 41% last quarter alone -- my hunch is that earnings should probably grow a lot more than 15% a year if sales keep up their brisk clip. Meanwhile, free cash flow at Zynga is already decidedly positive -- $213 million in cash profits generated over the last 12 months, and up more than double in comparison to where the company was at this point last year.
Valued on free cash flow, Zynga's 26 times FCF valuation is a whole lot cheaper than the stock's P/E makes things look. And if Wedbush is right about the growth exceeding expectations, well, should free cash grow at anywhere near the rate sales grew last quarter, I can't see Zynga's share price remaining in the single digits for long.
While hardly a "gimme," Zynga stock does show promise, and I'm inclined to think that Wedbush is right to recommend it.
