Why Did LegalZoom Stock Drop 27% Last Month?

Shares of LegalZoom (LZ -0.35%) tumbled 26.5% in May, according to data from S&P Global Market Intelligence. The stock moved sharply lower following its quarterly earnings report, then extended those losses throughout the rest of the month.

Quarterly earnings raised concerns

Investors were disappointed when LegalZoom published quarterly financial results on May 7. The company fell just short of analyst expectations for both sales and earnings, though the headline figures were roughly in line with the company’s forecasts. LegalZoom’s guidance for next quarter suggests no additional growth, but its full-year outlook is unchanged.

Image source: Getty Images.

Those results don’t seem sufficient to trigger a big drop, but it’s important to consider the wider context and key performance metrics.

LegalZoom is dealing with challenging economic conditions and stiff competition, and those struggles are evident in its financial results. Small businesses are an important customer segment for the online legal services company. High interest rates and economic uncertainty are bad for small business activity — especially for business formation. It’s not an attractive time to launch a business right now, which harms demand for LegalZoom’s services.

Even in good times, online legal services are a relatively slow-growth and fragmented industry. LegalZoom has a handful of established competitors, but thousands of online legal service businesses collectively hold nearly three-quarters of the market share. It’s difficult for any of these platforms to differentiate themselves.

Analysts expected only 5% revenue growth last quarter, and the company fell short of those expectations. LegalZoom fell short of expectations for several key metrics, including average revenue per subscriber, average order value, and the number of new business formations. These data points offer evidence of macro factors that are hurting the company’s financial performance and that conditions are even worse than previously feared.

The company’s short-term outlook is weakened by economic conditions, while competitive pressures cloud the long-term outlook. LegalZoom’s growth prospects are limited, and it doesn’t pay a dividend. Investors will struggle to find a compelling path to returns in this story.

The stock is cheaper now

A 26.5% sell-off looks harsh, even accounting for the above issues. LegalZoom delivered sales growth spearheaded by recurring subscription revenue. The company achieved operational efficiencies, driving nearly 30% operating profit expansion and 13% free cash flow growth.

LegalZoom’s profits climbed while its forecasts remained largely unchanged, causing the stock’s valuation ratios to drop.

LZ PE Ratio (Forward) data by YCharts

The forward P/E ratio below 20 implies expectations of a single-digit growth rate. If the company can outpace forecasts and maintain the current rate of cash flow expansion, it might gain some traction with value investors. Otherwise, it’s hard to see a catalyst for the stock.