It was an unusual up-and-down ride for shareholders of app monetization company AppLovin (APP -7.59%) last month. Midway through February, AppLovin stock was up by as much as 38%. But it then plunged by 36% from that peak to close out the month down 11.9%, according to data provided by S&P Global Market Intelligence.
AppLovin stock was riding high after the company reported its fourth-quarter results on Feb. 12. In Q4, the company grew its revenue by 44% year over year to $1.37 billion, which was an acceleration from its 39% growth in the third quarter and also around $100 million higher than analysts expected. Management was upbeat about the pace of adoption of its software, and this excited investors.
However, Wall Street’s exuberance quickly gave way to alarm as multiple short sellers — among them The Bear Cave, Fuzzy Panda Research, and Culper Research — published critical reports on AppLovin. Short sellers profit when a stock goes down, and it’s common for short firms to publish extensive research papers explaining their reasons for thinking that one is overpriced.
In fairness, AppLovin is still up more than 400% over the past 12 months even after its drop in February. In the wake of a hot run like that, it’s not uncommon for a stock to take a breather.
The risks that investors are contemplating
I believe short reports are more potent when investors are jumpy to begin with. AppLovin investors were undoubtedly getting antsy about the potential valuation risk baked into the stock price. In just the past two years or so, the stock had gone from trading at just 1.2 times sales to nearly 38 times sales at one point in February.
APP PS Ratio data by YCharts.
That’s not to say that the short reports are necessarily without merit. Those reports all allege practices at AppLovin that could get it banned from Apple‘s and Alphabet‘s respective mobile operating systems. Considering that AppLovin helps get its clients’ apps downloaded by more users, it would be catastrophic for the business model if it were to get banned from iOS or Android.
However, if we’re going to give airtime to the short sellers, we should also balance that by weighing the findings of other researchers, such as FundamentalBottom, that suggest those concerns are overblown. Prominent analysts from Bank of America, Wells Fargo, and other institutions have also come to AppLovin’s defense. Moreover, AppLovin CEO Adam Foroughi refuted the short sellers’ claims in a post of his own.
What to do now with AppLovin stock
I would personally give AppLovin the benefit of the doubt in regard to its business practices. And that makes its upside potential compelling. The company is just starting to branch out from mobile gaming into e-commerce, which is just the first of many potential diversifications to come. In short, its growth engine could continue humming for years.
That said, investors should always sufficiently understand the businesses that they’re invested in. For those who can neither make heads or tails of the assertions made by the short sellers nor the counterarguments made by others, it’s perfectly acceptable to recognize that AppLovin is a company with a business model that’s not easily understandable, and turn one’s attention and investing dollars toward other opportunities.
Wells Fargo is an advertising partner of Motley Fool Money. Bank of America is an advertising partner of Motley Fool Money. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, AppLovin, Apple, and Bank of America. The Motley Fool has a disclosure policy.
