This Just In: Upgrades and Downgrades


At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the worst...
It's been a rough couple of weeks for investors in the mobile gaming industry lately. On Monday, Zynga (NAS: ZNGA) followed up on its bleak Q3 forecast by announcing a plan to lay off 5% of its workforce, and "sunset" 13 of its mobile and social games. Adding insult to injury, the bad news for Zynga failed to dent investor enthusiasm for its main partner in games distribution, Facebook (NAS: FB) , which turned a report of robust growth in mobile advertising into about a 20% gain in market cap yesterday.

Now comes the snapback from Wall Street, as it begins to ratchet down expectations for the rest of the industry as well. The first casualty, it appears, is rival mobile gamer Glu Mobile (NAS: GLUU) . As recently as a week ago, Glu was on the move as it received a buy endorsement and a $5 price target from ace software analyst Stifel Nicolaus. But just yesterday, another fan of the company -- National Securities -- announced it was walking back expectations.

Downgrading the stock from buy to just "accumulate" -- a rating some analysts will tell you means "buy less," while others will confide actually means just "hold" -- NatSec cut its 12-month target for Glu shares to just $3.96. And while this still leaves some room for upside, the analyst's new rating is more than 20% short of Stifel's estimation, and about 35% below what NatSec previously estimated for Glu's true worth.

What, then, are investors to make of the new rating? Should you buy the stock and hope for NatSec's promised 17.5% profit? Should you stick tight with Glu, because after all, the analysts' ratings do seem to endorse it? Or should you...

...sell Glu Mobile?
Actually, I think the best play here may be to get ahead of the analysts as they begin turning more negative on Glu. Take a look at the numbers, and starting thinking about what could go wrong.

Consider that, no matter what analysts say about how Glu shares might perform in the future, one thing's for certain: Right now, today, Glu really isn't that great of a business. Over the last 12 months, Glu has managed to lose $26 million. The company's cash flow statement shows that things aren't quite as bad as GAAP makes them look, but even so, the company's $9.2 million in trailing negative free cash flow still isn't great news for investors.

Worse, projections for the upcoming earnings release (due out Nov. 1) suggest we could be looking at a GAAP loss of as much as $0.06 per share at Glu -- three times the damage incurred in last year's Q3. In short, if Glu shares have underperformed the S&P 500 by more than five percentage points over the past year, they've done so for a reason. So far, Glu's business just doesn't seem all that sticky.

A better idea
Fortunately, though, in a world populated with 10,000 stocks, even if companies like Zynga and Glu don't work out, investors still have a wealth of alternatives to invest in. Electronic Arts (NAS: EA) , for example, may not look like much of a bargain at 74 times earnings. But at least it has earnings (something Glu can't say about itself). And EA generates more than twice as much free cash flow as it reports as GAAP net income.

At an enterprise value of 23 times annual free cash flow, I won't say EA is the cheapest stock on the planet. But with earnings projected to grow at almost 17% per year over the next five years, it's not the most expensive, either.

Activision Blizzard (NAS: ATVI) , meanwhile, remains a powerhouse in computer gaming. Its enterprise value-to-free-cash-flow ratio is about 8.6 -- a veritable bargain price, considering that most analysts expect Activision to grow its profits at a better-than-10% annual rate over the next half decade.

Perhaps best of all, the stock pays shareholders a tidy 1.6% dividend for their patience as they wait for Mr. Market to wake up from his faddish infatuation will all things mobile, and discover that yes, Virginia, there are profitable gaming companies you can invest in.

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Fool contributor Rich Smith owns shares of Activision Blizzard. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 296 out of more than 180,000 members. The Motley Fool owns shares of Activision Blizzard and Facebook and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend Activision Blizzard, Electronic Arts, and Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Originally published