Although PENN Entertainment (currently trading at $17.40 per share) has gained 14.5% over the last six months, it has trailed the S&P 500’s 24.7% return during that period. This may have investors wondering how to approach the situation.
Is now the time to buy PENN Entertainment, or should you be careful about including it in your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free for active Edge members.
Why Do We Think PENN Entertainment Will Underperform?
We're sitting this one out for now. Here are three reasons there are better opportunities than PENN and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
Reviewing a company’s long-term sales performance reveals insights into its quality. Even a bad business can shine for one or two quarters, but a top-tier one grows for years. Over the last five years, PENN Entertainment grew its sales at a 10.4% compounded annual growth rate. Although this growth is acceptable on an absolute basis, it fell short of our standards for the consumer discretionary sector, which enjoys a number of secular tailwinds.
2. Cash Burn Ignites Concerns
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
While PENN Entertainment posted positive free cash flow this quarter, the broader story hasn’t been so clean. Over the last two years, PENN Entertainment’s demanding reinvestments to stay relevant have drained its resources, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 2.2%, meaning it lit $2.17 of cash on fire for every $100 in revenue.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, PENN Entertainment’s ROIC has decreased significantly over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
PENN Entertainment falls short of our quality standards. With its shares trailing the market in recent months, the stock trades at 22.1× forward P/E (or $17.40 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are better investments elsewhere. Let us point you toward the most dominant software business in the world.
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