Is Zynga Inc Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Zynga (ZNGA) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Zynga's story, and we'll be grading the quality of that story in several ways:

• Growth: Are profits, margins, and free cash flow all increasing?
• Valuation: Is share price growing in line with earnings per share?
• Opportunities: Is return on equity increasing while debt to equity declines?
• Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Zynga's key statistics:

ZNGA Total Return Price data by YCharts.

Source: YCharts. *Period begins at end of Q1 2011. ^Share-based data begins in Q4 2011 following Zynga's IPO.

ZNGA Return on Equity (TTM) data by YCharts.

Source: YCharts. *Period begins at end of Q1 2011.

How we got here and where we're going
It's been two and a half years since Zynga hit the public markets with a bang, only to have its early surge end in a whimper. Since then, the casual gaming kingpin has not only lost significant ground on a fundamental basis, it's also lost significant cachet in the casual-gaming arena to newly public rival King Digital (KING.DL).

However, Zynga has picked up a surprising three out of seven possible passing grades today, although two of those seem to be more technicalities than legitimate victories, considering the fact that the company's profits have not improved in three years. Can Zynga break the gaming-company curse and justify its early hype, or will continued poor performance force investors to uninstall Zynga's shares from their portfolios? Let's dig deeper to find out.

Investors hoping for a turnaround were disappointed this year, as Zynga's shares have given up all of their first-quarter pop, and then some, after King Digital filed for its IPO in March. Zynga's 2014 high-water mark was actually reached right around the time King's financials became known, and it's become quite popular for analysts to compare the two companies ever since.

It's not exactly a fair comparison, as King remains more reliant on a single game for its success than Zynga has ever been during its publicly traded life, but nonetheless, it's an unflattering comparison, since Zynga's key metrics continue to slide quarter after quarter. It's quite possible King's metrics will begin dropping -- in fact, some already are -- but for the time being, it's still a far more profitable company than Zynga has ever been.

While Zynga might not depend on a single game the way King does, it has had great difficulty developing new blockbusters in-house. Earlier this year, the company bought rival casual-game developer NaturalMotion, only to announce cost-cutting efforts that further reduced its already-demoralized workforce. Its newest game, the FarmVille franchise-extender Country Escape, had only been installed four million times by late June, compared to more than ten million downloads for NaturalMotion's Clumsy Ninja within a week of its late-2013 release.

Even though NaturalMotion brings proven hits to the table, investors need only reflect on Zynga's disastrous OMGPop acquisition -- which was meant to add then-blockbuster Draw Something to the Zynga lineup, but which instead resulted in a massive writedown -- to see how Zynga's previous splashy buys have worked out for its bottom line.

The divergent fortunes of Zynga and King Digital do help highlight two unfortunate problem with gaming companies in general, and with Zynga in particular. Most developers are so heavily reliant on one monster hit that simply failing to generate multiple blockbusters can result in a player exodus. Zynga's biggest in-house hit remains CityVille, which peaked years ago at over 61 million monthly active users, and which has actually outlasted its sequel, which was launched in late 2012 but only lasted four months.

And despite Zynga's highly publicized move to mobile, the company still remains lashed to Facebook's (META -2.95%) platform, which delivered three-quarters of Zynga's revenue last year. By contrast, the runaway success of King's mobile-friendly Candy Crush franchise transformed that company from a Facebook-focused developer that earned more than 80% of its revenue from Facebook in 2011 to one that earned less than 30% of its revenue from Facebook gamers two years later. To justify the fading hopes of a few determined investors, and to improve its standing as a company, Zynga must find its own mobile-first blockbuster. Without that breakthrough, the company is likely to continue sinking.

Putting the pieces together
Today, Zynga has few of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.