Note: This article has been amended to better reflect Zynga Inc (NASDAQ:ZNGA)’s liquidity position and management.
Earning season provides investors with the opportunity to gain insight in to not only how a company has performed recently but also whether the company is heading in the right direction. The companies I discuss below should be avoided, either because of a negative outlook or simply because the upside is limited.
Second quarter results were good, but not good enough
The company missed on calculated billings, which grew by 34% year-over-year; this was a drop from normalized first quarter billings growth of 37%. Total calculated billings of $109.6 million were below the expectation of $111 million. Investors need to take this data and consider the fact that the company has limited upside considering the company is trading at a higher valuation compared to their peers. The company has an estimated price-to-free-cash-flow ratio of 15.1 times compared to an industry mean of 8.3 times, implying that the company is “expensive.”
Investors should consider whether the quarterly results were good enough to justify a premium valuation and question whether the stock can continue outperforming the market.
I believe that the shares can see some limited downside to the mid $80s range as investors lock in profits. This is likely considering that shares are up around 40% year to date. I also believe that shares of the company may remain at these levels as NetSuite Inc (NYSE:N) has indicated that it cannot match its prior growth moving forward. Despite the fact that the company is still profitable, its upside can be limited and investors should be encouraged to seek other alternatives that offer a higher growth prospect.
Nothing has changed: same disappointing story
Zynga Inc (NASDAQ:ZNGA) reported a second quarter that beat on both the top and bottom lines. Shares were down 14% on Friday, however, as investors rushed to abandon ship following the announcement that the company will no longer pursue a gambling license in the US. The gambling license would have promised investors a lucrative new venue stream provided by a real-money online casino.
This mirrors when Zynga Inc (NASDAQ:ZNGA) shares grew 15% in one day back in April following the announcement that real-money online gambling would be brought to the United Kingdom through Facebook and mobile platforms.
Those investors still remaining need to consider the fact that the company faces the same challenges it has for the last few years. The company’s only real success came in 2010 with the “CityVille franchise.” Investors are likely to expect further negative downside as the possibility of a quick turnaround is not likely under the new leadership.
The company has $1.2 billion in cash and short term investments and no debt, buying it time to recreate itself, perhaps through strategic acquisitions. I would not stick around to find out with money on the line, however. Don’t take my word for it, either; take the CEO’s words that “We anticipate two to four quarters of volatility as we work through resetting and developing our strategy for growing top-line revenue and profit.”
Slowing PC and high-end smartphone attach rates creates risks
Dolby Laboratories, Inc. (NYSE:DLB) announced that the fourth quarter profits will come in the $0.30 to $0.36 range which is below consensus. Investors will look at the secular challenges facing the PC market (slowing demand), the decline of optical media, and growing saturation of the company’s addressable mobile opportunity as demand begins to slow down. All of these factors will put pressure on the company’s growth outlook. The company’s fourth quarter guidance suggestions a material deceleration that will continue going in to the 2014 fiscal year.
Without an improved growth outlook or a more aggressive strategy for returning cash to shareholders, investors need to stay clear of this company. Dolby Laboratories, Inc. (NYSE:DLB) is operating in an environment that continues to work against it.
My take
Despite the fact that all three of the companies mentioned have released earnings that came in above consensus estimates, investors need to pay attention to the longer-term picture. Doing so can provide a glimpse into the future, and all three companies are likely to be trading at lower prices given the negative outlooks surrounding them.
Jayson Derrick has no position in any stocks mentioned. The Motley Fool recommends Dolby Laboratories and Netsuite. Jayson is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Three Companies You Should Avoid After Earnings originally appeared on Fool.com is written by Jayson Derrick.
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