Workiva: Calls Make More Sense (NYSE:WK)

Trading Charts on a Display

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It’s been about 34 months since I suggested investors switch to calls in lieu of shares in Workiva Inc. (NYSE:WK), and in that time the shares are up about 97% against a gain of 52% for the S&P 500. I thought I’d review the stock again to see if it’s worth buying or not. I’ll make this determination by reviewing the financial history here. In addition, I’ll look at the stock as a thing distinct from the underlying business. Finally, I suggested that investors buy calls in lieu of shares, and I’m absolutely champing at the bit to describe how that trade worked out. I hope I’m not spoiling the surprise, but call buyers did “less badly” than stockholders.

Welcome to the “thesis statement” portion of the article, dear readers. It’s here where I walk you through the “gist” of my argument, in case you missed the title and skipped past the three bullet points above. I write this “thesis statement” to save you time and to save you from the trauma that my writing can induce. Your quiet appreciation for the fact that I so obviously care about you people is all the thanks I need. I’m of the view that the financial performance has improved dramatically over the past few years. The past year was financially great for the company, and now there’s “only” an r=-.34 correlation between revenue and net income. Strangely, that’s an improvement from the last time I reviewed this business. The problem, as is frequently the case, is the valuation. While the enterprise has improved, the stock has climbed, and there’s little value here in my estimation. Just because I don’t want to buy at current levels doesn’t mean the shares aren’t going to rise in price from here, though. After all, the shares have climbed dramatically in price in the teeth of 9+ years of losses. The shares are governed by the mood of the crowd, so they may well rise from here. In my view, the best way to “play” that dynamic is with call options. These offer investors most of the upside at far less risk.

Financial Snapshot

In some ways, the financial performance has been quite good. In particular, revenue jumped by about 26%, and gross profit grew by just under 30% from 2020. The result of this is that the net loss shrunk from $48.7 million in 2020 to $37.7 million in 2021. Additionally, things look good when compared to 2019, also. Relative to 2019, revenue in 2021 was up by about 49%, and loss from operations leapt from a loss of $45.5 million in 2019. Finally, the company maintains a very hefty war chest, suggesting to me that creditors and owners have given it the resources it needs to sustain losses for the foreseeable future.

Also, in my previous missive on this name, I complained about the strong negative relationship between sales and profits. For the stats nerds who are interested, the relationship with r=-.87. I asked the question of this company that I ask of so many others: if growing sales doesn’t lead to growing profits, what does? Things have improved somewhat on that front since I last looked at this business. Now the negative relationship between revenue and net income is “only” r=-.34. In my view, it’s still not great that after all this time there’s a negative relationship between the top and bottom lines, but things are now moving in the right direction.

Given the extent to which things have improved as of late, I’d be comfortable buying this stock at the right price.

A financial history of Workiva from 2013 to the present.

Workiva Financials (Workiva investor relations)

The Stock

Some of you who follow me regularly know what time it is. It’s the point in the article where I turn into a real “downer” because I remind investors that interesting companies like this one can be terrible investments if you overpay for them. Even if a company makes a great deal of money, and this one certainly isn’t, the investment can still be a terrible one if the shares are too richly priced. This is because this business, like all businesses, is an organisation that takes a bunch of inputs, adds value to them, and then sells them for a profit. That’s all a business is in the final analysis. The stock, on the other hand, is a supposed proxy whose changing prices reflect more about the mood of the crowd than anything to do with the business. In my view, Workiva shares themselves demonstrate this idea clearly enough. The shares have risen dramatically based on the crowd’s belief that the company will eventually turn profitable. In my view, stock price changes are much more about the expectations about a company’s future, and the whims of the crowd than anything to do with the business. This is why I look at stocks as things apart from the underlying business.

I feel a sudden urge to belabour a point even more than usual, so that’s what I’m about to do. I’ll demonstrate the importance of looking at the stock as a thing distinct from the business by using Workiva stock itself as an example. The company released annual results on February 22nd. If you bought this stock that day, you’re up about 5.7% since then. If you waited until April 1st to pick a date totally at random, you’re down about 11.4% since. Obviously, not much changed at the firm over this short span of time to warrant a 17%+ variance in returns. The differences in return came down entirely to the price paid. The investors who bought virtually identical shares more cheaply did less badly than those who bought the shares at a higher price. This is why I try to avoid overpaying for stocks.

My regulars know that I measure the cheapness (or not) of a stock in a few ways, ranging from the simple to the more complex. On the simple side, I look at the ratio of price to some measure of economic value like sales, earnings, free cash flow, and the like. Ideally, I want to see a stock trading at a discount to both its own history and the overall market. In my previous article, I made much of the fact that the price to free cash flow ratio was north of 375. While things are much improved, the shares are still quite expensive on a price to free cash flow basis, per the following:

Chart
Data by YCharts

In addition, it’s obvious that the market is now paying near multi-year highs for $1 of sales, per the following:

Chart
Data by YCharts

In addition to simple ratios, I want to try to understand what the market is currently “assuming” about the future of this company. In order to do this, I turn to the work of Professor Stephen Penman and his book “Accounting for Value.” In this book, Penman walks investors through how they can apply the magic of high school algebra to a standard finance formula in order to work out what the market is “thinking” about a given company’s future growth. This involves isolating the “g” (growth) variable in the said formula. Applying this approach to Workiva at the moment suggests the market is assuming that this company will grow at a rate of about 10.5% over the long term. This is excessively optimistic in my view, especially in light of the ongoing losses. Given all of this, I can’t recommend buying at current levels.

Options As An Alternative

Just because an old fuddy-duddy like me doesn’t see value here doesn’t mean the stock won’t go up in price from here. After all, the stock has climbed dramatically in the teeth of 9+ years of negative earnings, so I can understand the desire to be bullish here. Additionally, the analysts who cover this stock seem to believe the stock will turn a profit in 2024, and that will impact the price positively in my view.

The problem isn’t that the stock will go down in price. I can’t predict that it will, given that the crowd has driven it higher. The problem is that we need to achieve our returns as free of risk as possible. In my view, we want to achieve maximal returns with as little capital at risk as possible. Call options give us this opportunity. The investor achieves much of the upside offered by the stock, with downside limited to the amount paid for the stock. I’ll use the example of the call that I recommended last time to demonstrate the point.

In case you forget, I recommended buying the January 2020 calls with a strike of $55 for $7.60 when the stock was trading at $55. These calls obviously expired worthless in January of 2020, when the stock dropped to ~$42 per share. The call owner suffered a loss of $7.60, but the stock owner was down $13. Had the stock gone up in price, the call holder would have received much of that upside while risking only 14% of the capital that shareholders put at risk. So, limited capital at risk which captures most of the upside is a powerful combination in my view, and for that reason, I would suggest that bulls employ this strategy again.

In particular, I think the October calls with a strike of $110 make the most sense here. These are currently asked at $16.50, so for only 15% of the capital at risk, the call owner captures most of the upside that the shareholder gets over the next six months. If the shares languish from here, the call buyer will suffer, obviously, but may very well suffer far less than the stock owner. This is what happened to the calls I recommended last time, and so it may very well happen again.

While I can’t recommend buying the stock, and I won’t buy these calls myself, I would recommend them for people who insist on staying long here.

Conclusion

I’m of the view that this stock remains too expensive relative to the cash flow generating capacity of the firm. For that reason, I won’t be investing in it. Things have improved, obviously, but they haven’t improved enough to warrant a buy here. Additionally, it seems that the market “sees” that things have improved and the shares have climbed as a result. For that reason, most of the good news has already been priced in. Further, I think the people who want to remain long here would do well to switch from shares to call options. In my view, these offer investors most of the upside at far less risk. These instruments offer me the opportunity to remind investors that we’re not interested in “returns.” We’re interested in “risk-adjusted returns”, and calls are a superior vehicle in this instance.

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