AppLovin Faces Growth Issue After S&P 500 Update

Late Friday, AppLovin APP was one of three names to be added to the S&P 500 ahead of the opening bell on Monday, September 22. 

That makes the closing bell on Friday, August 19 the all-important print for funds mandated to track the nation's broadest large cap index. Some funds with mandates that grant them latitude to use their heads can start building those required long positions early or even carry on past the official date.

Others will have to time their sales of the three stocks being deleted from the index and their entry into the three firms being added over a very short window closely tied to that last regular session trade on that Friday. What investors have likely seen since Friday night is traders and speculators trying to get ahead of those funds that are mandated to act. That's why these stocks have moved as they have since the closing bell this past Friday.

As mentioned, AppLovin won't be moving toward a higher level of fund participation alone. Joining advertising tech company AppLovin in the S&P 500 on the morning of September 22 will be retail trading app Robinhood Markets HOOD and construction operation EMCOR Group EME. The three firms being deleted from the index to make room for these firms are MarketAxess Holdings MKTX, Caesars Entertainment CZR and Enphase Energy ENPH.

Earnings

About a month ago, AppLovin went to the tape with the firm's second quarter financial results. 

The firm posted an adjusted EPS of $2.49 or GAAP EPS of $2.39, both of which crushed expectations. The firm also generated revenue of $1.26 billion, which not only beat Wall Street, but was good enough for year-over-year growth of 77.2%. This was an acceleration in annual sales growth from 71% and 44% from the two prior quarters. At the time, AppLovin took the low end of the firm's guidance for Q3 revenue above what had been the consensus view.

AppLovin will report its results for the current quarter on or close to November 5. Currently, Wall Street is looking for earnings of an adjusted $2.58 per share on revenue of $1.34 billion. Results like that would compare the $1.47 for the year ago comparison while reflecting annual sales growth of a modest 12% or so. While the revenue generation may moderate, this does imply significant improvement in margin creation. Of the 18 sell-side analysts that I can find who cover APP, 13 have revised their Q3 earnings estimates to the upside, while five have left their estimates where they were. There are no downward revisions.

Fundamentals

The firm has been a cash flow beast, growing operating and free cash flows like May wheat. For the first six months of the fiscal year, AppLovin has generated operating cash flow of $1.604 billion, almost doubling the pace of the prior year, while spending almost nothing on capital expenditures.

The balance sheet is in solid shape as well, at least for the time being. The firm's current ratio stands at 2.74 with a cash position of $1.193 billion and no short-term debt on the books. AppLovin does have $3.511 billion in long-term debt on the balance sheet that will at some point have to be managed. The firm does produce the free cash flow to take care of that debt-load, but that would require repurchasing fewer shares for the firm's treasury which is something the firm has been doing aggressively.

My Thoughts

This is a great business, and its shares are valued as a growth stock. At 53 times forward looking earnings, the 77% sales growth might be expected, but we know that growth is starting to slow. That could be an issue. No, don't short the stock. Not now anyway. Maybe after all of the speculators and front-runners are done and then the funds that have no choice plow in maybe then. A short sale close to the closing price on Friday, September 19 might make sense.

Do You See What I See?​

I don't know where the stock will go over the next two weeks. We do know that these capital flows will not be driven by either fundamental nor technical analysis. ​However, once the fun is over, we have what looks like a huge double top pattern of reversal under construction. Relative strength is close to being technically overbought and may end up there later on Monday. The daily MACD is postured rather bullishly. That will be reinforced for the short-term.

Look at where the important moving averages are, though. The two averages where we know professional money will either fight or flight are the 50-day SMA and the 200-day SMA. Those lines currently stand at $399 and $350, respectively, with the last sale at $537-ish. That's a huge air pocket once the mandated moves are satisfied.

As a trader, I may play this small from the long side just to participate and try to make a few bucks, but looking out to the medium-term, I think there may be a huge, short trade idea in the making here. Potentially epic, as a matter of fact.

At the time of publication, Guilfoyle had no positions in any securities mentioned.