In many ways the financial markets are like infants; they are greedy, fickle, and fearful. Unfortunately, fads and bubbles come and go as quickly as children grow bored of new toys. Social media companies are the market's current new toy and could easily be discarded tomorrow.
Zynga, Inc. (ZNGA) is a social gaming company which IPO'd recently. Zynga has caught the attention of the markets. ZNGA shares closed at $14.69 after its first month of trading, making Zynga's market capitalization $10.68 billion. Should intelligent investors ignore operating losses and high price to sales multiples in order to buy ZNGA shares?
Certainly not. Zynga is not the only gaming stock. In fact, there are many stocks in the gaming space with attractive multiples and sound financial histories. Moreover, many of these companies seem like they are in the bargain bin, not in a bubble.
As alternatives to Zynga, consider the following stocks with strong track-records and solid credit scores:
10-Year Average ROE
Activision Blizzard, Inc.
Multimedia & Graphics Software
Toys & Games
Toys & Games
Multimedia Games Inc.
Internet Information Providers
These alternative stocks are all categorized as "safe" according to the Altman Z-score,* indicating that they are not considered bankruptcy risks. Moreover, the average 10-year return on equity (from the last ten reported fiscal years) demonstrates that these stocks have a track record of growing shareholder wealth. It is clear from these two metrics that each of these four alternative stocks is a "high" quality stock capable of weathering bad times and delivering positive long-term results.
What's more, these stocks are cheaper and have respectable growth prospects:
EPS growth past 5 years
EPS growth next 5 years
Analyst estimates for Zynga's earnings growth are suspicious since the firm does not turn a profit. After all, going from no profit to a profit is an infinite increase. Philosophical issues aside, predicting the business models of established, profitable firms is precarious and is much more difficult for emerging firms without histories of positive returns.
In the long run, Zynga's earnings and future cash flows will determine its value. The future financial potential of a stock can be gauged by using financial metrics to determine how cheaply a stock is priced, its ability to weather hardship, and its growth potential. Based on lower price-to-sales ratios and calculable price-to-earnings ratios these stocks are cheaper than Zynga. Better yet, they have impressive track records and "safe" credit scores. Rather than invest in shiny new ZNGA shares, consider a diversified mix of these four securities as a more attractive alternative.
*Please read the article disclaimer.