I feel like I have a chronic case of déjà vu. Every morning, as I look at the financial news, I have the urge to write the same story. That story goes something like this: “Company ABC released earnings that beat expectations on both the top and bottom line, but the stock dropped. Why is that?”
In many cases, it has been because of reduced guidance or warnings about a possible slowdown later this year. In those cases, the good fourth quarter is ignored, and traders react to the guidance which, given the forward-looking nature of the market, makes some sense. Confusingly though, the opposite is also true. When a company reports a slightly disappointing Q4 2021 but talks positively about the coming year, the market focuses on the bad news for the last quarter and the stock drops on that, too.
Traders are collectively in a bad mood, it seems, and companies just can’t win. That makes me reluctant to identify stocks to buy on what looks like an illogical reaction to earnings but, sometimes, the reaction is just too mind-bogglingly ridiculous to be ignored. When a company reports better-than-expected EPS and revenue, while also increasing their forecast for revenue growth, and the stock still gets hit hard, you have to pay attention even if you are a bit tired of bargain-hunting in a market whose reaction to every bit of news is to sell.
DraftKings (DKNG) did that when they reported this morning. They showed a narrower-than-expected loss on greater-than-expected revenue, while raising revenue guidance for the rest of the year. Here’s how the stock reacted in the premarket:
As I write, DKNG is off 15% from yesterday’s close.
If you look hard enough, you can find a reason, of course. Despite the better-than-expected revenue guidance, the company did cut estimates for EBITDA over the coming year. In other words, they said they expect to do more business, but lose more money doing it. Under normal circumstances, that would be bad news, but DKNG has an excuse.
The opening up of the country to sports gambling is happening piecemeal as states pass legislation one at a time, and each time a new market opens, DKNG and its rivals all fight for market share, offering ridiculously good deals to new bettors. These include deposit match bonuses and “no-brainer” bets where, for a limited amount, players can get good odds on obvious outcomes, such as on two teams combining for at least one point in a game. Player incentives aren’t the end of the expenditure either. If you live in a state where online gambling is legal and have ever watched a game live on TV, you will know that the advertising spends of the licensed companies are pretty big too.
Put simply, each time a new state opens up to online gambling, DKNG throws money at that market, but they do so for a reason. As any casino operator will tell you, bettors, like everyone, are creatures of habit. Once you have loyal customers, they will keep giving you money.
Inevitably, the push for sign-ups hurts profitability in the short term, but it can therefore be looked at as a form of capital expenditure, an investment in the infrastructure of the company. The infrastructure here happens to be human, but this is still money spent as an investment. DraftKings is busy buying future growth, but the market is placing minimal value on growth right now, so their stock is being punished. That may fit the mood at the moment, but moods change.
A year or so ago, the mood was completely different. Then, growth potential was prized, and DKNG was trading in the $70s. Potential, however, is hard to value. It isn’t about crunching numbers as much as it is about feelings, and when we make decisions on feelings, we often exaggerate the response. That is what happened a year ago to the upside, but it is also what is happening now to the downside. The fact is that DKNG beat on the top- and bottom-line last quarter and are busy investing in future growth, but the stock is back nudging its all-time lows. That makes it a buy, no matter how tired you may be of the “stock gets hit illogically on earnings” story.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.