Is Grom Social Enterprises a Hidden Gem or a Value Trap? An In-Depth Analysis
Value-focused investors are always on the hunt for stocks that are priced below their intrinsic value. One such stock that merits attention is Grom Social Enterprises Inc (NASDAQ:GROM). The stock, currently priced at $0.25, recorded a loss of 14.1% in a day and a 3-month decrease of 37.73%. According to its GF Value, the stock's fair valuation is $6.73.
Understanding GF Value
The GF Value represents the current intrinsic value of a stock derived from our exclusive method. The GF Value Line on our summary page gives an overview of the fair value that the stock should be traded at. It is calculated based on three factors: historical multiples (PE Ratio, PS Ratio, PB Ratio and Price-to-Free-Cash-Flow) that the stock has traded at, GuruFocus adjustment factor based on the company's past returns and growth, and future estimates of the business performance. If the stock price is significantly above the GF Value Line, it is overvalued and its future return is likely to be poor. On the other hand, if it is significantly below the GF Value Line, its future return will likely be higher.
However, investors need to consider a more in-depth analysis before making an investment decision. Despite its seemingly attractive valuation, certain risk factors associated with Grom Social Enterprises should not be ignored. These risks are primarily reflected through its low Altman Z-score of -6.9, and the company's revenues and earnings have been on a downward trend over the past five years. These indicators suggest that Grom Social Enterprises, despite its apparent undervaluation, might be a potential value trap. This complexity underlines the importance of thorough due diligence in investment decision-making.
Altman Z-Score: A Measure of Financial Health
Before delving into the details, let's understand what the Altman Z-score entails. Invented by New York University Professor Edward I. Altman in 1968, the Z-Score is a financial model that predicts the probability of a company entering bankruptcy within a two-year time frame. The Altman Z-Score combines five different financial ratios, each weighted to create a final score. A score below 1.8 suggests a high likelihood of financial distress, while a score above 3 indicates a low risk.
Company Snapshot: Grom Social Enterprises
Grom Social Enterprises Inc is a social media, technology, and entertainment company for kids focused on producing original content. In addition to providing a social media platform, the company creates content consisting of animated characters, interactive charts, videos, blogs, and games. With a market cap of $2.20 million and sales of $5.20 million, the company's operating margin stands at -146.22, and it has a Return on Invested Capital (ROIC) of -31.53 and a Weighted average cost of capital (WACC) of 66.39.
Dissecting Grom Social Enterprises's Low Altman Z-Score
A dissection of Grom Social Enterprises's Altman Z-score reveals that the company's financial health may be weak, suggesting possible financial distress. The first factor we need to consider is a measure of short-term liquidity. This is calculated as the working capital divided by total assets. The data provided: 2021: 0.34; 2022: -0.37; 2023: -0.02, shows that Grom Social Enterprises has experienced a recent decline following an initial increase in its Working Capital to Total Assets ratio over the past few years. This decline suggests potential liquidity issues that the company may be facing. The ratio is strikingly low, which unfavorably influences the overall Z-Score.
When it comes to operational efficiency, a vital indicator for Grom Social Enterprises is its asset turnover. The data: 2021: 0.33; 2022: 0.16; 2023: 0.19 from the past three years suggests a decreasing trend in this ratio. The asset turnover ratio reflects how effectively a company is using its assets to generate sales. Therefore, a drop in this ratio can signify reduced operational efficiency, potentially due to underutilization of assets or decreased market demand for the company's products or services. This shift in Grom Social Enterprises's asset turnover underlines the need for the company to reassess its operational strategies to optimize asset usage and boost sales.
The Bearish Signs: Declining Revenues and Earnings
One of the telltale indicators of a company's potential trouble is a sustained decline in revenues. In the case of Grom Social Enterprises, both the revenue per share (evident from the last five years' TTM data: 2019: 62.62; 2020: 44.09; 2021: 32.75; 2022: 11.83; 2023: 3.02; ) and the 5-year revenue growth rate (-35%) have been on a consistent downward trajectory. This pattern may point to underlying challenges such as diminishing demand for Grom Social Enterprises's products, or escalating competition in its market sector. Either scenario can pose serious risks to the company's future performance, warranting a thorough analysis by investors.
Even more worrying is the 3-year EBITDA growth rate and the 5-year EBITDA growth rate, both of which are negative. This could indicate structural problems within the company, as EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is often used as a measure of a company's operating performance.
The Red Flag: Sluggish Earnings Growth
Despite its low price-to-fair-value ratio, Grom Social Enterprises's falling revenues and earnings cast a long shadow over its investment attractiveness. A low price relative to intrinsic value can indeed suggest an investment opportunity, but only if the company's fundamentals are sound or improving. In Grom Social Enterprises's case, the declining revenues, EBITDA, and earnings growth suggest that the company's issues may be more than just cyclical fluctuations. Without a clear turnaround strategy, there's a risk that the company's performance could continue to deteriorate, leading to further price declines. In such a scenario, the low price-to-GF-Value ratio may be more indicative of a value trap than a value opportunity.
Conclusion
After a comprehensive analysis, it appears that Grom Social Enterprises might be a potential value trap. Despite its seemingly attractive valuation, the company's declining revenues and earnings, low Altman Z-score, and potential liquidity issues paint a bleak picture. Investors should exercise caution and conduct thorough due diligence before considering an investment in Grom Social Enterprises.
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This article first appeared on GuruFocus.
