Bear of the Day: Changyou.com (CYOU)

It is tough to say exactly where stocks are heading next, as the bears grew even louder last week despite relatively strong earnings results for our market bellwethers. That said, it does seem prudent to continue avoiding underperformers in volatile businesses. One example right now would be Changyou.com (CYOU).

Changyou is a Chinese video game company. It is primarily involved in developing what are called MMOs, or massive multiplayer online games. This is an interesting model because it means Changyou derives a lot of its revenue from in-game purchases and the sale of virtual goods.

While this is solid growth trend driving the broader video game industry right now, Changyou has not recently seen the type of results we would like to see.

CYOU's struggles started about a year ago. In October 2017, the company reported earnings which missed consensus estimates by more than 100%. Changyou went on to miss estimates in the next two quarters as well, leading to one-year losses of about 70% for the stock.

Changyou is expected to report its latest quarterly results soon, and hopes for a rebound are muted right now. That is because earnings estimates for the soon-to-be-reported quarter have fallen significantly in recent weeks. In fact, the Zacks Consensus Estimate for the period now sits at $0.26 per share, down from $0.43 that was expected just over a week ago.

Changes made to earnings estimates shortly before report dates are powerful indicators because analysts typically have more information about current business conditions.

We also believe changes made to forward-look earnings estimates can be indicators of near-term share price performance. The Zacks Consensus Estimate for CYOU's current full-year and next-year earnings has also been lowered recently, and that has earned the stock a Zacks Rank #4 (Sell).

It is possible that one would look at CYOU's huge decline over the past year and assume that it is now a value play. After all, the stock is now sporting an “A” grade in the Value category of our Style Score system, and valuation metrics like its P/E of 11.3 and P/S of 1.2 are certainly interesting.

But we believe that these metrics are only value indicators when a company's earnings outlook is also trending higher. Buying a sluggish stock with a poor earnings outlook is risky, even if it looks to be on the cheap.

Moreover, investors looking for value should also be looking for companies with healthy balance sheets. Changyou has witnessed a significant deterioration of its cash position this year, with total cash and equivalents falling from $978 million at the start of 2018 to just $571 million at the end of the most-recently-reported quarter. Liabilities have increased from $607 million to $791 million in that time.

Investors should also recognize that conditions for the broader Chinese internet market remain volatile. These stocks have been battered this year, as evidenced by a 32% decline in the KraneShares China Internet ETF (KWEB). CYOU is likely feeling the effects of wider concerns about its Chinese internet peers.

Luckily, our “Internet – Content” group does offer some options for those looking for positive earnings trends in the industry. For instance, Global Eagle Entertainment (ENT) and Yelp (YELP) both sport Zacks Rank #2 (Buy) designations right now.

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