When the pandemic hit, gambling stocks became a hot commodity. With much of the population stuck inside with surplus entertainment funds in their pockets, it was the perfect opportunity for online gaming stocks to thrive. DraftKings (NASDAQ:DKNG) is one such beneficiary. But the DKNG stock price has moderated somewhat over the past year, it’s down 15% so far in 2021. That’s not too shabby considering the price is still around four times higher than it was in 2019.
But what’s next for DKNG stock?
You could argue that the past 18 months were about as good as it gets for a gambling play and DraftKings still doesn’t turn a profit.
However, DraftKing’s position as a sports betting specialist gives it a unique edge in the developing U.S. market and if it can play its cards right, it may become a leader in the global market.
Cash Is King
As the saying goes: “revenue is vanity, profits are sanity but cash is king.”
It’s a little reminder that no matter how impressive the top line is: cash generation is the most important part of a successful business.
DraftKings’ third quarter results boasted an impressive 60% increase in revenue, but profits remained in the red. The group’s underlying loss widened considerably to $313,603.
It’s not uncommon for a business like DraftKings to be unprofitable. The business is relatively new and the focus is on getting new users hooked. The group added just over 300,000 new users over the past year, but to do that DKNG had to increase its marketing spend by 50%.
Was it Worth it?
Ultimately, what matters most is how sticky those customers are. Monthly Unique Players are defined as people who spent money at least once on the platform. If half of those users are people who put a $5 bet on a football game and never returned, then it was a waste. But if they come back month after month to play, then that’s money well spent. It’s expensive to go out and find new customers, so repeat gamers are an important part of the long-term value proposition.
The good news on that front is that customer retention has been strong so far, rising to 87% last year.
DKNG Stock’s Path to Profitability
A big part of the story for DraftKings is relaxing gambling restrictions in the U.S. The group expects the U.S. gaming market to be worth roughly $40 billion once it’s been legalized in all 50 states.
There’s no guarantee this will happen, but as more restrictions relax, it looks like the direction things are going.
There are currently 15 states that allow sports betting and DraftKings is currently operational in 12 of those. Based on its New Jersey operations, management thinks it will take approximately two years to become profitable in a new state.
The takeaway is that although DKNG stock isn’t backed by a profitable company, management’s able to articulate a clear path to profitability.
The single biggest risk to DraftKings is regulations. The gambling industry is a contentious one. And it will always draw criticism from politicians.
The wave of legalization over the past few years has created an accommodative environment for companies like DraftKings and may have given investors a false sense of security. There’s no guarantee that legalization will continue, and even if it does, it could take much longer than expected.
There’s also a social consideration to keep in mind.
ESG investing has been a hot topic and with all the going green talk recently, it’s easy to forget that it’s more than just protecting the environment. The “S” in ESG stands for “Social” after all, and it means many investors are hesitant to make investments in companies that are seen as harmful to the population.
Gambling stocks fall into that category.
That’s not to say they’re necessarily a bad investment — tobacco companies and beer makers bump up against the same issues and plenty have delivered impressive returns. But it’s worth bearing in mind that there are many investors and funds that will never buy a stock like DKNG. As they could also become the target of scrutiny later down the line.
The Bottom Line on DKNG Stock
DKNG stock’s got a solid growth story and management appears to be capable of executing that growth.
There’s always a risk something could go wrong with a young, unprofitable company like DraftKings. And with the nature of the online gambling business, these risks are even higher.
Currently, DKNG shares change hands for around 14 times sales, which certainly isn’t cheap.
But the group’s operating leverage means if revenue growth can stay on track it could be capable of delivering bumper returns as it expands.
On the date of publication, Laura Brodbeck did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Laura Brodbeck has a Finance degree from Duquesne University and has been writing about financial markets for the past 8 years. Her work can be seen in a variety of publications including InvestorPlace, Benzinga, Yahoo Finance and CCN.