Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Stock market analysts like to say that the "market is forward-looking," and that what a stock has done in the past isn't always as important as what it's going to do in the future. Investors in FireEye (NASDAQ: FEYE) had better hope they're right about that.
Since its IPO in 2013, FireEye has taken investors on a wild ride, more than doubling in the six months after going public, only to plunge below its IPO price three months later. At a recent share price below $16, this internet security specialist still trades 20% below its $20 IPO price of three years ago, a fact due in no small part to the company's failure to ever earn a GAAP profit -- or generate a full year's worth of positive free cash flow.
But Piper Jaffray thinks all this is about to change.
Image source: Getty Images.
Upgrading FireEye stock
Piper Jaffray believes that after five long years of booking little but losses, FireEye stock is poised to deliver "positive operating income and free cash flow starting in 3Q18."
FireEye specializes in cyberattacks -- more specifically, in preventing them when possible, detecting them when not, and then proceeding to "remediate" the damage. This should be a good business to be in, here in our era of cyberhacking and internet espionage. However, FireEye's sales growth stalled out last year, rising just 5% in comparison to 2016 numbers -- a big letdown from the 15% sales growth enjoyed in 2016, and the 46% growth achieved in 2015.
Last quarter, however, CEO Kevin Mandia advised investors that in an effort to restart growth, FireEye is updating the "pricing and packaging" of the services it offers. According to Piper Jaffray, these efforts are bearing fruit. "Our channel contacts noted that the new pricing bundles are having a positive impact on overall demand trends," explains the analyst in a note covered on StreetInsider.com (subscription required).
Things are going so well, in fact, that Piper Jaffray decided to upgrade FireEye stock to overweight and assigned it a new $20 price target.
Bargain shopping on the internet
Can FireEye reach this goal that Piper Jaffray has set for it? One reason the analyst is optimistic is because, as Piper explains in its note, FireEye shares trade "well below the peer group average (3.2x EV/CY19E Sales vs 4.7x for the peer group)," and thus have room to grow.
You'll notice that in making its comparisons, however, Piper Jaffray bases its estimations on FireEye's sales, not its profits. This is because FireEye doesn't actually have any profits on which to value its stock. (Rather, it's racked up losses of nearly $1.9 billion over the past five years, according to data from S&P Global Market Intelligence.) Because Piper Jaffray is itself forward-looking, though, it's recommending FireEye stock based on how well the company might perform in the future.
So how does that future look?
Gazing into the crystal ball
S&P Global has the answers for us here. According to its survey of Wall Street analysts, precious few of them expect to see FireEye turn GAAP-profitable anytime soon. Pro forma profits, on the other hand, could arrive as early as this year. (The consensus is for FireEye to earn $0.02 per share before accounting for one-time items in 2018.)
Personally, I don't give a lot of weight to pro forma numbers -- but the news on the free cash flow front is just as encouraging. According to the consensus of analysts who track FireEye, the stock is likely to produce positive cash profits of $18 million this year, nearly triple that cash haul (to $53 million) in 2019, and more than double it again in 2020 (to $122 million). It will take another two years to double FCF again -- $253 million is anticipated in 2022.
FireEye stock today is trading for about 12 times that final estimate for FCF production. Given that $253 million would represent 30% annual earnings growth in 2022, you might think that's an attractive price. (Piper Jaffray certainly seems to.) The problem, of course, is we're talking about hypothetical free cash flow four years out, and that FCF may or may not appear as promised -- and if you ask me, four years is a bit too far out to be investing with any confidence that the future will shape up as planned.
Meanwhile, in the here and now, FireEye is still growing sales only in the double-digit range and earning no profits on those sales. In the final analysis, therefore, although I understand Piper Jaffray's bull argument in favor of FireEye, I just can't recommend the stock until the company has proven itself capable of earning the profits and generating the cash that Piper Jaffray thinks it can.
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