Applied Digital has been on fire lately. In the past six months alone, the company’s stock price has rocketed 61.6%, reaching $27.76 per share. This was partly thanks to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is there a buying opportunity in Applied Digital, or does it present a risk to your portfolio? Get the full breakdown from our expert analysts, it’s free.
Why Is Applied Digital Not Exciting?
We’re happy investors have made money, but we're sitting this one out for now. Here are three reasons you should be careful with APLD and a stock we'd rather own.
1. EPS Barely Budging
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
Applied Digital’s full-year EPS was flat over the last three years. This performance was underwhelming across the board.
2. Free Cash Flow Margin Dropping
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.
As you can see below, Applied Digital’s margin dropped by 79.8 percentage points over the last five years. Almost any movement in the wrong direction is undesirable because it is already burning cash. If the trend continues, it could signal it’s becoming a more capital-intensive business. Applied Digital’s free cash flow margin for the trailing 12 months was negative 476%.
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.
Applied Digital burned through $1.34 billion of cash over the last year, and its $2.61 billion of debt exceeds the $1.91 billion of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.
Unless the Applied Digital’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 Applied Digital until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Applied Digital’s business quality ultimately falls short of our standards. After the recent rally, the stock trades at 63.2× forward EV-to-EBITDA (or $27.76 per share). Investors with a higher risk tolerance might like the company, but we think the potential downside is too great. We're pretty confident there are more exciting stocks to buy at the moment. We’d suggest looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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