Is MGM Stock Worth the Gamble Right Now?
In spite of being beat down a little lately from disappointing earnings, some investors are starting to really like the potential of MGM’s stock now. Is it worth taking a chance on?
The MGM brand became famous for its motion pictures, then known as Metro-Goldwyn-Mayer. The company was bought by casino and airline magnate Kirk Kevorkian in 1969, who had a vision of leveraging this very famous brand to get into the casino business. 10 years later, the two hotel-casinos they operated at the time were making most of the company’s money, and the studio was spun off as they concentrated on growing the resort side of things.
The company is now known as MGM Resorts International and is a worldwide leader in the casino business, with a particularly strong presence in Las Vegas. It also owns properties in Atlantic City, Washington, D.C, Detroit, and in Macau, the hotbed of gambling in Asia.
It’s no real secret that the gambling business has been in a down cycle lately, but MGM hasn’t really fared that badly, even though this is far from being a hot stock. It is starting to attract some real interest though, where investors feel that the $25 range that it is now trading at offers a tempting value play given that their projected earnings as a multiple of their stock price may eventually bring enough new interest to get its stock heading back in the right direction.
MGM does provide us a valuable lesson on how little of a role that future earnings or durable business fundamentals like assets can play where the movement of a stock’s price is concerned. In October 2007, MGM hit a new all-time high of $96.40 per share. Just a year and a half later, it traded at $1.99 a share. The company had not gone belly up, as this epic loss would suggest, and while their business certainly slowed down during the recession that we were in at this time, this in itself shouldn’t have produced anywhere near this much of a change in their stock price, because stock prices look toward the future and the future at no time was all that bad for MGM.
Instead, what happened is that the stock just got unloved by investors, and this is how much damage falling out of favor can cause. The company did lose money during this time but were perfectly capable of bearing the losses. These losses which should not have been all that concerning sent people fleeing for the exits and willing to pay far less and sell for far less than would even be imaginable given how successful this company has been over the years.
Why this is an important lesson is because we need to be very careful with what we consider to be value plays, where we take how much money the company makes per share and measure it by how much the share costs, because this actually does not matter very much and generally is a red flag, not a green one.
Low Earnings Multiples Should Be a Warning Sign if Anything
Hot stocks and hot companies have higher prices relative to their earnings, where cold stocks and companies have lower ones. We may cite a number of different reasons why some stocks are hot and some are cold, but ultimately it comes down to the demand for the shares in the market.
Many people don’t really understand how the stock market works, including investors of all levels of prominence, and instead of looking at the force which moves stock prices, this demand, they look at all sorts of other things, like the earnings multiples or free cash flow that they are focused on now. These both can contribute to a stock’s growth, if the company makes more money and then keeps more if it in cash to buy back stock, and stock buybacks influence demand directly, but we cannot simply count on a company doing more of this to see its price go up in a manner that would be appealing.
If they do enough to please the market, the market will reward them. If we look at the market and see that it is displeased, we’re going to need to expect with a reasonable level of confidence that their sentiment will turn around. While we may have some ideas about this, they need to be confirmed, otherwise they just won’t be and we’ll be left with a wrong guess.
Differences in demand are what cause the wide distribution of earnings ratios that we see out there, and while a lot of companies have fairly average ratios, as this diverges, it is representative of either an excess or a lack of demand for the stock.
MGM’s earnings multiple is on the low side right now, and what we can take from this is that not a lot of investors are crazy about it. It is not that earnings don’t matter, as they do influence investors, for instance the 80 cents a share that MGM earned in 2018 after making $3.34 a share in 2017 isn’t going to excite too many people. These things exert their force by changing the demand for a stock, and we can see where the demand is and has changed over time by just looking at its chart.
On the other hand, MGM shares being worth only a couple of dollars and their losing 97% of their value in less than 2 years is a different story. A price like this doesn’t make sense or even close to it, and this would be a great example of a good value play, not because of any value calculations, but simply because this is a case of a stock being extremely oversold as we call it.
The reaction to the downside was obviously overdone, to the extreme in fact, although when playing these reversals, it is extremely important to wait until we get confirmation that the massacre has ended. Otherwise, we call this trying to catch a falling knife, where you’ll likely just get cut.
In theory at least, we could see the price of something drop so much that earnings start to matter, where the yield of dividends becomes so large that it starts to compete seriously with the reason why people buy stocks generally, the potential for the stock price to increase. When things are this bad the company won’t be paying dividends because they will be losing money. If you hang on to the stock until things turn around, the price of the stock will rise as well, and when they do pay out dividends, the yield on them will be fairly inconsequential as they usually are with common stocks that move anywhere near at the rate of the market.
Compared to $1.99 a share, MGM’s $25.54 of today may look simply fabulous, but hitting the exact bottom is almost impossible without encountering several losing trades along the way, and we really need to get a stock to prove itself before we should risk jumping in. In spite of coming so far in 10 years, if we waited until it was relatively safe, the returns since then would be rather unremarkable and below the market return.
MGM’s Skies Look Rather Gray Right Now
If we’re wondering where MGM is headed from here, which we must do if we’re either holding the stock or considering buying it, we can’t just look at things like earnings ratios over the next year or two. Even though we’re at least looking forward when we use future earnings projections, this always comes down to how much the stock market likes a stock, and we cannot just assume there is a strong enough correlation here, because there actually is not.
MGM has limited plans for expansion, which isn’t a good thing, but this is expected to grow their free cash, money that can be spent on dividends or stock buybacks. We really don’t want to get too excited about dividend growth, because this is not why people buy stocks, and this therefore has a limited potential to affect demand.
Share buybacks increase it, and if this is pursued aggressively enough it can drive the price of a stock quite a bit, by both directly affecting it and creating some positive momentum where other investors jump in to join the party.
This will be offset in this case by things like people’s concerns about the casino business in general, the economy slowing down, and whatever else people are looking at when they decide on the stock.
If MGM were stepping up and buying a lot of stock now, and this was having its desired effect, we would see this reflected on the charts. The charts are where the rubber meets the road, where we see the quantification of the effects of anything and everything upon a stock’s price. We don’t even have to worry so much about why it is moving, as the fact that it is moving is all we really need to know, because this is the data that matters and the only data that matters in fact.
MGM just doesn’t look that impressive, in spite of people thinking that it is underpriced. If it really was, in the eyes of the market that is, we’d see this being corrected, but we are not right now.
MGM may have its day in the sun again, and while it may be a very long while before they put a scare into the $100 a share mark again, moving back more toward $35, the high-water mark since its collapse 12 years ago, might be reasonable at some point. We will need a lot more excitement with it then we’re seeing right now to make this happen though.
The upside with MGM is actually quite limited, and when the company is currently beat down by a meaningful amount and you’re hoping that it might put in a modest increase, it does not make sense to get too excited here. If people are investing for 20 or 30 years, and the stock is currently stuck in the ditch as MGM is, they can afford to be patient and wait for things to actually look good before they leap, which simply makes sense.
The time to roll the dice is not now as we should always be looking to place our bets when the odds are more in our favor. When we consider the potential return and risk, and especially in comparison to much better-looking plays, stocks that are moving up with the market rather in the wrong direction, and have exciting business prospects right now instead of rather mundane ones, this make MGM not all that good of a bet right now regardless of how long you are hoping to own it.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
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