What a fantastic six months it’s been for Skillz. Shares of the company have skyrocketed 78.9%, hitting $7.96. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Skillz, or does it present a risk to your portfolio? Dive into our full research report to see our analyst team’s opinion, it’s free.
Why Do We Think Skillz Will Underperform?
Despite the momentum, we're sitting this one out for now. Here are three reasons you should be careful with SKLZ and a stock we'd rather own.
1. Declining Paying Monthly Active Users Reflect Product Weakness
As a video gaming company, Skillz generates revenue growth by expanding both the number of people playing its games as well as how much each of those players spends on (or in) their games.
Skillz struggled with new customer acquisition over the last two years as its paying monthly active users have declined by 24.5% annually to 146,000 in the latest quarter. This performance isn't ideal because internet usage is secular, meaning there are typically unaddressed market opportunities. If Skillz wants to accelerate growth, it likely needs to enhance the appeal of its current offerings or innovate with new products. 
2. Cash Burn Ignites Concerns
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
Skillz’s demanding reinvestments have drained its resources over the last two years, putting it in a pinch and limiting its ability to return capital to investors. Its free cash flow margin averaged negative 36.8%, meaning it lit $36.79 of cash on fire for every $100 in revenue.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Skillz burned through $67.59 million of cash over the last year. With $238.7 million of cash on its balance sheet, the company has around 42 months of runway left (assuming its $126.8 million of debt isn’t due right away).
Unless the Skillz’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Skillz until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
We see the value of companies helping consumers, but in the case of Skillz, we’re out. Following the recent surge, the stock trades at 1.2× forward price-to-gross profit (or $7.96 per share). While this valuation is optically cheap, the potential downside is huge given its shaky fundamentals. There are more exciting stocks to buy at the moment. Let us point you toward one of Charlie Munger’s all-time favorite businesses.
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