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Get into Zynga Inc Stock Before Its Imminent Breakout

Bret Kenwell

Zynga Inc (NASDAQ:ZNGA) hasn’t done much so far in 2018, about flat for the first four and a half months of the year. However, the rally that Zynga stock has staged so far in May is largely responsible for that flat performance.

ZNGA stock is up 56 cents per share from $3.40 at the start of the month. While a 16.5% rally is nothing to scoff at, much more upside could be in the cards if ZNGA can breakout over the $4 mark.

Let’s look at the charts first to see the setup and then look at the underlying business.

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Trading Zynga Stock

As you can see on the chart below, there is big-time resistance up near $4. Zynga stock hasn’t sustainably seen these levels in years and getting above it would do wonders for bulls’ confidence. The question is, can it?

chart of Zynga stock breakout


Click to Enlarge

We’ll talk about the earnings in a minute, but on May 2, the company beat on revenue expectations, reported a profit and gave investors news worthy of cheering. That was the spark to the big rally. There are positives and negatives with this chart though, so let’s start the latter.

Unfortunately, ZNGA stock is pretty extended, as the name has had a big rally over a short period of time. The relative strength index (RSI) measures how overbought or oversold a stock is.

With a reading north of 70, Zynga stock is becoming overbought (blue circle). The MACD, which measures momentum, favors the bulls at the moment but could begin to exhaust based on prior action over the past year.

Now for the good news. First, I wouldn’t base an entire thesis on the MACD and RSI metrics alone. So why use them? The RSI and MACD are great complements to a strong thesis, not metrics we base a thesis on.

Case in point, Zynga can continue to rally and keep its overbought reading for days, weeks or in some cases even longer. Last May, we saw Zynga’s MACD extend quite far (orange circle at the bottom of the chart).

Further, Zynga stock is above all three major moving averages. It would be quite healthy to see a pullback down to $3.75 and for it to hold as support. That would let ZNGA digest some of its big rally and give it the energy it needs to push through $4.00.

Finally, last May we saw the start of a 32% rally with a powerful move on earnings. Could the same happen here?

Voting on ZNGA Stock

So what was behind the powerful rally? The quarter was okay, but far from amazing. Earnings per share came in at just a penny while revenue grew about 6% year-over-year (YoY). Sales guidance for next quarter was solid and management again expects further profit growth. Those are all fine, but the real news came from the founder.

Zynga had different classes of stock, affecting the voting power for investors. Companies like Facebook Inc. (NASDAQ:FB) can get away with allowing its founder and CEO to have outsized control. But when the company has been floundering, investors aren’t too keen on putting their money on the line, especially when they don’t have voting power!

Founder Mark Pincus is converting his stock into regular common stock, cutting his voting power down to 10% from 70%. You can see why, as an institutional investor, it would be unattractive to invest in a company that essentially allows its founder to make all the decisions while not allowing investors any real power.

Now that Wall Street feels it can get some control, investors feel more comfortable owning Zynga stock. Particularly with ZNGA having some momentum right now. Judging by the stock’s reaction, that seems to be the case.

The Bottom Line on ZNGA

So what’s the bottom line here? ZNGA stock isn’t exactly cheap, but at roughly 28 times this year’s earnings, it’s not wildly overvalued. Forecasts call for 55% earnings growth this year and almost 30% next year. That’s on revenue growth of just 7.3% this year and 9% next year. That bodes well for margins.

Investors who want to limit their risk can buy ZNGA stock on a pullback to $3.75 and use a stop-loss on a close below $3.40. If the stock breaks below that level, there is essentially no support below. Risk-averse bulls can wait for a breakout and close over $4.00 and buy into momentum.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.

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