Financially, DraftKings (DKNG -2.02%) as a company seems primed to only go up. The stock, on the other hand, faces a push and pull between a high valuation and the positive news the company will benefit from. The main factor in the stock's ultimate trajectory is how far out into the future growth of the company are investors willing to speculate. So far, it seems they are factoring in well more than five years of future financial growth in betting stocks.
The growth of the industry is there
The U.S. gambling market has been valued differently by different analysts. Some have estimated the size of the U.S. market will reach about $8 billion in 2025. With DraftKings currently valued at around $20 billion, there's obviously a bit of a disconnect there. Because the industry is so new, it's tough to tell what a proper premium is for the industry.
Sales have grown quickly since the company went public, with revenue nearly doubling to $132.8 million from the second quarter of 2020 to the third. Given the growth nature of the business, losses have also grown substantially. DraftKings reported a loss of $347.7 million in the third quarter ended Sept. 30, which works out to a loss of $0.98 per diluted share.
The financial story for this company is entirely based on growth. DraftKings' stock is reactive to scalable revenue potential. Is there a way to link the finances and the stock?
Connecting the dots
I bought DraftKings earlier in 2020 and eventually sold most of my position when the stock was approaching $60 a share. The simple reason was the stock had run too hot for too long. The sports betting industry is easily one of the most promising new markets in the United States, with similar potential to the legalized cannabis market.
Like many stocks within the industry, DraftKings shares have seen this constant tug-of-war between the speculation on the potential of that market and the company's financial performance thus far. Let's be clear, DraftKings' market capitalization of $20 billion is absurd in relation to the company's financials. The 2021 guidance calls for revenue of $750 million to $850 million. That doesn't justify $20 billion in market capital, no matter how you swing it. This is a growth stock, and has to be looked at in terms of its long-term potential.
As evidenced by stocks like Amazon or Tesla, attempting to connect high-growth names with their underlying finances can be a tricky ordeal. With DraftKings, I think you have to look at the company's place within the industry. It is a leading name, with an established user base from fantasy sports. Overall, I like the look of shares in the low to mid-$40s. The volatile stock has pulled back several times into that range, and is set up for more limited downside.
Over the long term, I don't think a growth stock like DraftKings has anywhere to go but up. The two main players in terms of branding power are DraftKings and Penn National Gaming (through its investment in Barstool Sports). In my view, gambling will become primarily an online event. The convenience of smartphones and laptops outweighs casinos, and DraftKings is one of the names most established in that space. As more states look at legalization, the market for DraftKings is only going to increase.