iQiyi (NASDAQ:IQ) stock is headed downhill further. Management of the Chinese online streaming company gave a very bleak growth outlook during its second-quarter conference call. Moreover, it looks like IQ will continue losing money. That means IQ stock will keep falling.
To start with, management indicated that revenue would only increase between 1.5% and 7.5% in Q3. And to be clear, Q2 revenue grew only 1.5% from$1.0 billion to $1.015 billion.
IQiyi lost money in Q2, as you might suspect. In fact, the company has never yet made any money. We don’t know if it is free cash flow positive. The company does not produce quarterly cash flow statements. The company lost $339 million on $1.015 billion in revenue in the quarter, or a 34% negative net margin. That loss is 30% bigger than the Q1 red ink, a loss of $260 million.
There is really no end in sight to the losses. iQiyi does not even publish non-GAAP measures, such as its adjusted EBITDA numbers. That’s because it makes operating losses as well.
In fact, even its subscriber growth was paltry. At the end of Q1, it had 96.9 million paying subscribers. By Q2 this had grown to just 100.5 million, or just 3.8%.
IQ Stock Is Overstretched
So why is IQ stock trading like a high-flying growth stock? Its valuation is overly stretched. For example, IQ stock has an EV-to-revenue ratio of 11.7x. Even Netflix (NASDAQ:NFLX) stock trades at just 6.8x EV-to-revenue.
For the time being, IQ stock is in no danger of falling out of bed like NIO stock (NYSE:NIO). It has cash and restricted cash of about $965 million. I suspect that most of the operating losses translate into cash losses, given the company’s high capex costs on content.
That means it can afford to lose $267 million in operating cash flow losses for another three or four quarters without a cash injection or higher debt levels.
But here is what happens as losses rise and the cash balance falls: IQ stock will keep falling. It is already down 40% from its peak in March to just $16.50 today.
Ad Sales Add Problems
There are other things that don’t look good for iQiyi. The truth is, the Chinese economy is dragging down the growth in IQ’s advertising sales.
On top of that, IQ’s content costs are still increasing, especially going into the third and fourth quarters. Its online ad revenues were down 16% year-over-year.
Moreover, iQiyi is stepping into other areas where it really does not have a lot of expertise. That includes sports entertainment and gaming companies. They made a gaming company acquisition last year that is helping growth now.
But those kinds of business tend to be one- or two-hit winners and that is it. The eventual drop in revenue without new games that enthrall young people can actually be more harmful than the original increase in revenue.
Valuation Does Not Match the Risk-Reward
Matching risk and reward on money-losing stocks has long been a challenge for investors. “The risk of investing in an unprofitable company should also be more than offset by the potential return, which means a chance to triple or quadruple your original investment,” according to Investopedia.
I cannot honestly see that happening any time soon with IQ stock. Especially with the paltry growth in subscriber numbers.
Sometimes a high P/E stock provides a good deal of information about the potential risks of investing in that stock. In this case, the high EV-to-revenue ratio of IQ stock, especially compared to NFLX acts as a warning or potential red flag for the investor.
Another take on this — the fundamentals of growth investing vs. value investing — can be found in the academic research of Columbia University professor, Stephan H. Penman, and a University of Zurich professor, Francesco Reggiani. They suggest that investors should look at both the P/E ratio and the P/Book Value ratio of a stock to assess its risk.
What to Do With IQ Stock?
IQ stock has both a high EV-to-Sales ratio (11.7x) and a high Price-to-Book Value ratio (5.5x). Its revenue and subscriber growth are slowing down for a variety of reasons, as I have shown.
This does not bode well for IQ stock in the future. You would be better off to find a more value-oriented stock in this industry.
As of this writing, Mark Hake, CFA, does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here. The Guide focuses on high total yield value stocks with high yields, buybacks and other value characteristics. Subscribers receive a two-week free trial period.