ContextLogic (NASDAQ:WISH) is a mobile commerce company focused on North America, Europe and South American. Many analysts say that WISH stock is cheap. But they are overlooking one simple fact. The company is not profitable and does not produce free cash flow (FCF). I suspect the stock will stay cheap until it can show profits and FCF.
For example, last quarter ContextLogic had sales of $772 million, up over 75% from last year. But it lost $128 million and had negative adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) of $79 million. Moreover, its FCF was negative $354 million before investments and negative $340 million after investments.
ContextLogic’s Cheap Valuation
So you can see that this does not really make investors too excited, despite its stellar growth rate. For example, WISH stock has a market value of $6.865 billion as of June 16 at a price of $11.09, according to Yahoo! Finance. But analysts covered by Seeking Alpha estimate that it will make $3.32 billion in sales in 2021 and $3.81 billion by 2022.
That puts WISH stock on a price-to-sales multiple of 2.1 times 2021 forecast sales and 1.8 times 2022 sales. This is pretty inexpensive, especially when compared to Amazon (NASDAQ:AMZN) or even eBay (NASDAQ:EBAY).
For example, AMZN stock trades for 3.6 times 2021 sales and 3.05 times 2022 sales. Moreover, eBay is at 3.7 times 2021 sales and 3.5 times 2022 sales.
So this means that WISH stock is at about 60% of its peers’ P/S ratio for 2021 and 2022. But that 40% discount might be exactly where it should be.
The reason is Amazon and eBay are very profitable. For example, Amazon made $26.4 billion in the trailing 12 months (TTM) FCF on TTM sales of $254.5 billion. That works out to a TTM FCF margin of 10.37%. But ContextLogic had a quarterly negative 44% FCF margin (i.e., -$340 million FCF / $772 million in sales).
Ebay also had a positive FCF margin. It generated $959 million in FCF on sales of $3.023 billion. That represents a stellar FCF margin of 31.7%. So its cheap price-to-sales ratio makes it very undervalued.
So, you can see that it does not make sense to give ContextLogic a similar P/S ratio as Amazon and eBay, with their significantly higher profitability. That is just simple logic and math.
Where This Leaves WISH Stock
Analysts don’t see things my way. They are impressed with the company’s growth and think it should have a higher target price. For example, six analysts have written reports on WISH stock in the last 12 months, according to TipRanks. Their average price target is $18.60, or 66% above today’s price of $11.05.
The same is true at Seeking Alpha. Their review of 11 analysts’ reports has an average price target of $18.70. This is 68.6% over today’s price. Yahoo! Finance also has a similar price target from analysts: $18.44.
Whenever there is a wide gulf like this between my view, where I think the stock is fairly valued now, with little upside, and analysts, I use a probability matrix.
For example, let’s say that there is a good chance that analysts are right, say 40%, that it will rise 50%. Let’s say that my view, that the stock will likely stay close to its present price, also has a 40% chance of being right. And then let’s say there is a 20% chance that the stock will fall 20%, as it is still not profitable.
Here is how that works out: Scenario one: this leads to an expected return (ER) of +20% (i.e., 40% x 50%). Scenario two: this leads to a zero percent ER (i.e., 40% x 0% gain). Scenario 3: an ER of -4% (i.e., 20% x -20%). Therefore, the total expected return is +16% (i.e., +20%-0%-4%).
In other words, despite my view, the best expectation is that WISH stock will rise 16% over the next year to $12.86 (i.e., $11.09 x 1.16). That is a reasonable return, but nothing really to write home about. Keep in mind that WISH stock will not really move higher until it becomes profitable, either on an EBITDA or FCF basis.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.