Shares in cinema operator Cineworld (LSE: CINE) have had a great run recently. Since the start of November, Cineworld’s share price has risen from 29p to 75p. That represents a gain of around 160% in just three months.
Here, I’m going to look at why the company’s share price has surged. I’ll also discuss whether I’d buy the stock for my own portfolio today.
Cineworld’s share price has surged
Cineworld shares have risen for two main reasons. Firstly, news that Covid-19 vaccines have been developed has pushed the stock considerably higher. Investors clearly expect the outlook for the company – which has been forced to close the majority of its cinemas due to social distancing restrictions – to improve this year as the world comes out of lockdown.
Secondly, the stock has spiked recently as a result of its high level of short interest. On the back of their huge success buying heavily shorted stocks in the US, such as GameStop and AMC, Reddit traders have piled into heavily-shorted stocks in the UK such as Cineworld and Pearson.
I imagine some hedge funds have probably also closed their short positions after seeing what has happened in the US to heavily-shorted stocks. This buying activity has pushed Cineworld’s share price up significantly since mid-January.
Should I buy CINE shares today?
My investment strategy is based on ‘growth’ and ‘quality’. Essentially, I look for companies set to generate strong growth in the long term that are also financially sound. This strategy suits my investment goals and risk tolerance. Obviously, this approach isn’t suitable for everyone.
Taking a closer look at Cineworld, the stock doesn’t appear to meet my investing criteria. For a start, I believe Cineworld’s industry looks set to experience structural challenges in the years ahead due to changing consumer habits. Cinema operators face a lot of competition now from the likes of Netflix, Amazon Prime, and Disney. In the future, we could see more movies released direct-to-consumer as well.
Of course, Cineworld’s growth should pick up as the world comes out of lockdown. City analysts expect revenue this year to more than double from around $1bn to $2.3n. However, I have concerns about the long-term growth story here.
Secondly, I don’t see Cineworld as a high-quality company. Looking at the financials, a few things concern me. One issue is the large amount of debt on the balance sheet. In a recent update, the company advised it now has aggregate gross debt financing of $4.9bn. This large debt pile makes the company more vulnerable.
Another issue is the company’s profitability. In the three years before Covid-19, return on capital employed (ROCE) averaged just 7.5%. This tells me that, in the past, the company hasn’t made a large return on its invested capital.
All things considered, I don’t see Cineworld as a good stock for my portfolio. I like to invest in companies that are highly profitable and have strong balance sheets. Cineworld doesn’t tick these boxes at the moment.
I think there are other stocks I could buy today that have a better chance of being good long-term investments.
