The past six months have been a windfall for Sphere Entertainment’s shareholders. The company’s stock price has jumped 82.8%, hitting $116.50 per share. 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 Sphere Entertainment, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.

Why Do We Think Sphere Entertainment Will Underperform?

We’re glad investors have benefited from the price increase, but we don't have much confidence in Sphere Entertainment. Here are three reasons you should be careful with SPHR and a stock we'd rather own.

1. Long-Term Revenue Growth Disappoints

A company’s long-term sales performance is one signal of its overall quality. Any business can have short-term success, but a top-tier one grows for years. Over the last five years, Sphere Entertainment grew its sales at a 18.1% compounded annual growth rate. Although this growth is acceptable on an absolute basis, it fell slightly short of our standards for the consumer discretionary sector, which enjoys a number of secular tailwinds.

2. Mediocre Free Cash Flow Margin Limits Reinvestment Potential

Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.

Sphere Entertainment has shown poor cash profitability relative to peers over the last two years, giving the company fewer opportunities to return capital to shareholders. Its free cash flow margin averaged 7.5%, below what we’d expect for a consumer discretionary business.

3. Restricted Access to Capital Increases Risk

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.

Sphere Entertainment posted negative $431.5 million of EBITDA over the last 12 months, and its $961.5 million of debt exceeds the $507.8 million of cash on its balance sheet. This is a deal breaker for us because indebted loss-making companies spell trouble.

We implore our readers to tread carefully because credit agencies could downgrade Sphere Entertainment if its unprofitable ways continue, making incremental borrowing more expensive and restricting growth prospects. The company could also be backed into a corner if the market turns unexpectedly. We hope Sphere Entertainment can improve its profitability and remain cautious until then.

Final Judgment

We cheer for all companies serving everyday consumers, but in the case of Sphere Entertainment, we’ll be cheering from the sidelines. After the recent surge, the stock trades at 18.8× forward EV-to-EBITDA (or $116.50 per share). This valuation tells us a lot of optimism is priced in - we think there are better stocks to buy right now. Let us point you toward the most dominant software business in the world.

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