It's been about four months since I wrote my latest piece on 8x8, Inc. (NYSE:EGHT), where I suggested that investors avoid the shares, or express any bullishness with calls in lieu of stock ownership. Since then, the shares have collapsed about 52% against a loss of 8.7% for the S&P 500. The company has reported full year results since, so I thought I'd review the name yet again. After all, a stock trading at $6.90 is a much less risky investment than that same stock trading at $14.14. I'll determine whether or not it makes sense to buy here based on the latest financial results, and by looking at the stock as a thing distinct from the underlying business. In addition, I'm absolutely chomping at the bit to write about my "calls in lieu of shares" strategy, because it proved successful once again. I think writing about this will give me an opportunity to brag, which I love to do. Oh, and also there's an interesting lesson that investors can glean about how to reduce their overall risk.
I know that my writing can be a bit tough to take for some. For that reason, I offer a "thesis statement" in each of my articles that gives you the highlights of my thinking, so you can read the "gist" of what I'm droning on about, and then get out before you get hit with too much "Doyle mojo." You're welcome. Anyway, I'm of the view that 8x8 remains a poor investment until the company demonstrates the capacity to generate a profit. It's great that sales keep rising, but as the company grows sales, it also grows losses. This prompts a question I've found myself asking about a few companies recently: if growing sales won't lead to profits, what will? That said, the stock is much cheaper, so if the company manages to start turning a profits and the valuation remains at current levels, I'll jump on this stock with both feet. All of that said, I'm sometimes wrong. I was as shocked as you are now when I first learned that. It may be the case that the capricious crowd suddenly changes its tune and bids this stock higher. In that circumstance, call options would benefit. For that reason, I'm still of the view that people who are long here should buy calls instead of shares. They offer you most of the upside "flavor" at a fraction of the risk of "calories." Specifically, if I were long here (I'm not), I'd recommend the January 2023 call with a strike of $7.50. Thus ends my "thesis statement." If you read on from here, any trauma or nausea you feel as a result is on you.
The problems I referenced in previous articles persist. Relative to the same period in 2020, revenue in 2021 was up just shy of 20%, while net loss grew by just under 6%. The ongoing disconnect between revenue and net income is disconcerting in my view, because it's net income that is the source of sustainable owner returns. Sales are nice, but only if they grow the bottom line. That hasn't happened in this case since 2014.
In order to fund operations, the company has diluted the shareholder base, with shares outstanding growing at an eye-watering CAGR of ~125% from 2013 to now.
On the "plus" side, the per employee stock-based compensation has increased very nicely as the shares have fallen in price. The number of employees for 2021 isn't yet available, but stock-based compensation was about 24% higher in 2021 relative to 2020. From 2013 to 2020 (the last year of available data), per employee stock-based compensation has grown at a CAGR of ~19%, so some people are being treated well.
On the "non-sarcastic plus side", cash from operations was actually positive in 2021, a feat last achieved in 2017, so that's good. Also, as I pointed out in the previous article, the company has a pretty substantial cash hoard, though it's about $21.3 million lower now than it was in 2020. Also, as I pointed out in my previous article, the contractual obligations are about to make fairly significant demands on cash, so that's troublesome.
The "bottom line" for me is that this stock may be investible, but it would need to be priced at a significant discount to both the overall market and its own history.
In spite of the ongoing losses, this may be a decent enough investment on the principle that there's a disconnect between the company and the stock. Put another way, a very profitable company can be a terrible investment at the wrong price, and a perennial loser may be a great investment at the right price. This point becomes obvious when we recognize the distinction between "companies" and "stocks." In the final analysis, all companies are basically the same. A company takes a number of inputs, adds value to them, and tries to sell the various products and services it added value to at a profit. It doesn't always succeed in this, as demonstrated by the history of 8x8. Anyway, at their core, that's what all companies are. Stocks, on the other hand, are supposed proxies that reflect the changing fortunes of the company. In reality, they move based on the crowd's long-term perspective about a given company's future. Since the stock price changes much more rapidly than the company, we can infer that the crowd's pretty capricious. If the crowd feels 8x8's long-term prospects are good, the stock will rise higher, in spite of the current state of affairs.
I'll belabor this point home by using 8x8 stock itself as an example. Not enough time has passed since they released their latest quarterly results, so I'll use the previous period as an example. The company released its 3rd quarter results on February 2nd. If you bought the shares that day, you're down about 54% as of now. If you waited until the end of the quarter, you're down "only" about 9.3%. This obviously isn't a great outcome, but that's not the point. The point is that not enough changed at the firm to warrant a 45% variance in returns in such a short span of time. The difference in returns, and whether this stock was a "terrible" or simply "bad" investment came down entirely to the price paid. The person who bought the shares relatively more cheaply did less badly. This is why I'm obsessed with not overpaying.
My regular readers know that I measure the cheapness of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value, like earnings, free cash flow, and the like. These simple ratios are a handy starting place in my view. I like to see a company trading at a discount to both its own history and the overall market. In my previous missive, I characterized this stock as "close" to a buy because the price to sales was trading at 2.8 and price to book was trading around 11. The stock is now dramatically cheaper, per the following:
It seems that the market has abandoned hope in 8x8, which is a positive in my view. The stock is certainly cheaper, which is a positive, but I need to see it cheaper still or I need some evidence that the company has the capacity to generate a profit. For that reason, I continue to recommend people avoid this name. For people who disagree with me, there is a safer alternative, though, and that alternative has worked out relatively less badly over time.
In my previous article on this name, I suggested that people who insisted on disagreeing with me buy calls in lieu of shares. These offered most of the return "flavor" for a fraction of the risk of "calories." In particular, I recommended the August 2022 calls with a strike of $15, which were priced at the time at around $2.65. My logic was that, for 18% of the capital at risk, the investor would capture much of the upside of the stock. These last traded hands at $.15, so they've lost about $2.50 each in value as the stock price has collapsed. On the other hand, the stock has lost about $7.25 in value since I made this recommendation. Had the stock risen in price, the call holder would have done well.
This trade proved "successful" by being "less bad." In my view, people who insist on staying long here would be wise to engage in a similar trade yet again. I would only recommend risking ~18% of the value of the stock yet again, so if I were long (to be clear, I'm not), I'd recommend the January 2023 call with a strike of $7.50, which is currently asked at $1.40. Either the shares rise in price, at which point the call owner will benefit. The shares may continue to drop in price, at which point the call owner suffers less as the previous case suggests. Either way, they're exposing 20% of the capital as the stockholder, leaving 80% to generate a return elsewhere.
To sum up, then, I am not long. I'm not sanguine about the value of this stock, and I'll remain pessimistic about its prospects until the underlying company demonstrates the capacity to earn a profit. That said, I understand that the crowd cares more about some distant, bright future, and may drive the shares higher. If you are a person who is optimistic about the future here, I would strongly recommend you manifest that view with calls in lieu of stock. They give you most of the upside at significantly less risk.
I remain of the view that this company isn't worth considering as an investment until it demonstrates the capacity to generate a profit. I am of this view because it's actually profit that is the source of sustainable investor returns. That said, you may be shocked to learn that I'm sometimes wrong, and it may be the case that this stock catches a powerful bid, and is driven higher. In that circumstance, call owners would benefit. Thus, I think people who insist on staying long here sell their shares and buy calls instead. These give investors most of the upside at a fraction of the risk.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.