2023-05-17 15:15:42 ET
Summary
- The financial performance has improved dramatically in many ways in my view. Net losses have shrunk, suggesting a positive relationship between revenue and operating profits.
- In spite of this, the shares are trading near historical lows. We've been told by credible sources to be greedy when others are fearful.
- I'm taking a small, speculative position in this stock. Don't buy if you can't afford to lose this capital, as there's no way to know when the market will turn.
I thought I'd review the shares of 8x8, Inc. ( EGHT ) for a few reasons. First, the company has published financials since I last looked at the stock, and I feel compelled to review them. Second, the shares have dropped massively in price, and that has me intrigued. Finally, and most importantly, writing about 8x8 will help me feed my fragile ego, by giving me an opportunity to brag. To remind investors of my performance here, I turned bullish when the market became unduly pessimistic in September of last year, and then took profits when it became excessively optimistic in late February of this year.
More seriously, between September of last year, and February of this year, my long position made me a nice return, with the stock up about 24%. The stock is now back down again by about 36% from the time that I turned bullish last Fall. The lesson that I take from this is that this is very much a “trader’s stock”, and that you would be wise to not buy it and forget it. I think it makes sense to go long when the shares are cheap relative to the business, and take profits when the market gets ahead of itself. Given that the shares have dropped in price from $5.84 when I last reviewed the name to $3.12 at the moment, they may now represent good value. I’ll review the most recent financial performance, and the valuation to make that determination.
Welcome to the “thesis statement” portion of the article. It’s here where I give you the “gist” of my thinking, so you can then decide whether or not you want to wade through the entire thing. This is yet one more of the value added services I offer to readers, because I’m absolutely obsessed with making your lives as pleasant as possible, and I’d be absolutely grief stricken if you didn’t enjoy yourselves while you were here. You’re welcome. I think the financial performance has improved here somewhat. For instance, net loss has shrunk as revenue has grown, suggesting to me that there’s a positive relationship between the top and bottom lines. That wasn’t always the case here. Additionally, although the debt level is disturbing, the company has taken positive steps to reduce it, which I also consider to be a positive. Given that, I’d be willing to buy the shares at the right price. The market seems to have lost hope here, given that the shares are now cheaper than they’ve ever been by some measures. I like this combination, and for that reason I’m going to take a small, speculative position in this business once again. I’ll add to my stake if we get further evidence of a positive turnaround. For now, though, I’m willing to buy 1,000 shares. These may decline massively in price, so if you follow me on this trade, do so with capital you can afford to lose. Sometimes things get so “beaten up” that you can’t afford to pass on them. I think this is one of those times.
Financial Snapshot
The last year has been a good one in some ways in my view. For instance, revenue in 2022 was about 16.6% higher than it was in 2021, which is quite good, but is a persistent story for this company. As I’ve written before, revenue growth here has been quite good over the years. What’s more compelling in my view is the fact that net loss from operations and total net loss has shrunk massively from last year to this. Specifically, net loss from operations dropped from $154.1 million in 2021 to $66.3 million in 2022. Net loss dropped from $175.4 million last year, to “only” $73.1 million in 2022. The losses have not been this small since 2016, so I’d say that this performance has been noteworthy.
In my previous missive on this name, I droned on about the fact that the capital structure has diminished significantly recently. That written, the company seems to be taking steps to improve this situation somewhat. Since August of 2022, the company has paid down $58 million of their long term borrowings. This may have been driven by a spike in the interest expense from $2.271 million in 2021 to just over $23 million in 2022. Either way, the company seems committed to paying down debt, and that’s a positive.
I also like to see the fact that stock based compensation in 2022 was about $44 million lower than it was in 2021. This reduction is one of the reasons why share count actually declined for the first time since 2015.
Given the above, I’d be happy to buy back into the stock at the right price. I’d really hate to sound like a braggart, but I did generate a 24% return when I switched to bullish on this stock previously. So, I’d be happy to buy if the valuation makes sense.
The Stock
If you've been following me for any length of time, you know that I’m not inclined to become so attached to a stock that I’m never willing to let it go. Sometimes this doesn’t work out well, and sometimes it works out very well, as in this case of my 8X8 trade. My view is that I'd rather miss out on opportunities than risk overpaying for a stream of future cash flows, because I'm of the view that the more you pay for a given investment, the lower will be the subsequent returns. It’s also possibly the case that the less you pay for a given investment, the better will be your returns. This is the philosophy that informed my decision to go long in this stock last September.
Additionally, my regulars know that I consider the business to be different from the stock, and we need to analyse each separately. For example, every business buys a number of inputs, like the knowledge of software developers, for instance, and turns those inputs into a final service. The stock, on the other hand, is an ownership stake in the business that gets traded around in a market that aggregates the crowd's rapidly changing views about the future health of the business, future demand for video chat and contact services for small and mid-sized businesses, and so on. Additionally, the stock also moves around because it gets taken along for the ride when the crowd changes its views about "the market" in general. The stock may be affected by a host of variables that may be only peripherally related to the health of the business, and that can be frustrating.
This stock price volatility is troublesome, but it's a potential source of profit because these price movements have the potential to create a disconnect between market expectations and subsequent reality. In my experience, this is the only way to generate profits trading stocks: By determining the crowd's expectations about a given company's performance, spotting discrepancies between those assumptions and stock price, and placing a trade accordingly. I absolutely hate to remind you about my success here, but this is the approach I took successfully trading 8x8 recently. I've also found it's the case that investors do better/less badly when they buy shares that are relatively cheap, because cheap shares correlate with low expectations. Cheap shares are insulated from the buffeting that more expensive shares are hit by.
As my regulars know, I measure the relative cheapness of a stock in a few ways, ranging from the simple to the more complex. For example, I like to look at the ratio of price to some measure of economic value, like earnings, sales, free cash, and the like. I like to see a company trading at a discount to both the overall market, and to its own history. To refresh your collective memories, I went long last September when the shares were trading at a price to sales ratio of 0.825, and a price to book ratio of 4.331, and took profits when price to sales hit 0.952, and the market started paying 7.597 times book. Fast forward a few months and the shares are now very, very inexpensive by historical standards. For instance, the market is paying about $0.49 for $1 of sales, per the following:
The shares are at multi-year low valuations at a minimum, and are potentially cheaper than they’ve ever been. That, coupled with some of the financial positives I referenced earlier, has me intrigued.
My regulars know that I think ratios can be instructive, but I also want to try to work out what the market is "thinking" about a given investment. If you read my stuff regularly, you know that the way I do this is by turning to the work of Professor Stephen Penman and his book "Accounting for Value" for this. In this book, Penman walks investors through how they can apply some pretty basic math to a standard finance formula in order to work out what the market is "thinking" about a given company's future growth. This involves isolating the "g" (growth) variable in this formula. In case you find Penman's writing a bit opaque, you might want to try "Expectations Investing" by Mauboussin and Rappaport. These two also have introduced the idea of using the stock price itself as a source of information, and we can infer what the market is currently "expecting" about the future. Applying this approach to 8x8 at the moment suggests the market is assuming that this company will be bankrupt in about nine years. Given the recent improvements, I think that’s a touch pessimistic. I think the market’s thrown in the proverbial towel on these shares. I can’t resist being a contrarian here, so once again I’ll take a small, speculative position in this name.
For further details see:
8x8, Inc.: Too Cheap To Pass Up