Passing on Dave & Buster's, Chinese Stocks

Time to take a quick look at some Green Screen stocks that don't quite make the cut.

The Green Screen is a starting point. It is a mechanical filter that pulls out only stocks with strong revenue growth and cash flows. This is a quick way to filter the thousands of stocks available for investment down into a more manageable (150 or so) list to consider.

Still, there are some unattractive investment candidates that make it through. We are looking for sustainable growth and cash flows. Many times firms will show up due to short-term tailwinds such as spikes in commodity prices, recent acquisitions that provide one year growth bumps, or even big revenue windfalls that won't repeat (such as milestone payments for drug development).

We also want to avoid companies where the business risks offset or even outweigh the positives.

Today, a number of stocks get eliminated. Starting with...

Dave and Buster's (PLAY)

Dave and Buster's operates 150 very large (30,000-45,000 square foot) entertainment locations across the U.S. The company's catch phrase is "Eat. Drink. Play.", and that's a good description of the business. 23% of sales come from non-alcoholic food and drink in a casual dining-like restaurant setting. 11% of sales are from alcohol in its locations' bar areas. 67% of sales come from its gaming offerings, which include redemption games like video games, mini-sports games, air hockey, etc., and non-redemption games like billiards or bowling.

The firm's recent success is a COVID rebound story combined with a big acquisition - both things to be wary about. While pre-COVID, the company routinely saw same-store sales growth in the 1-2% vicinity, post-COVID it has been posting 8-12% numbers. It is unlikely that continues in future years.

Then there is the $835 million acquisition of primary competitor Main Event that closed in early 2022. This alone will add about 30% in sales for D&B in early 2023. However, it has also dirtied up the balance sheet. The combined company now has over $1.2 billion in debt, a scary 345% debt-to-equity ratio, and operating earnings only cover interest payments by 2-3 times, a pretty tight coverage ratio.

Finally, the business model is missing some important characteristics. Revenue is not recurring - folks may visit a D&B weekly, annually, or once in their lives. And there is no moat. Local bowling alleys or new competitors can copy the model if they wish, and switching costs are nil for customers.

Chinese Green Screen Stocks

5-10 years ago, Chinese stocks were all the rage, and why not? This was a country with the world's largest population, evolving into a world economic power. The country offered U.S. investors a number of rapidly growing, cash-gushing companies in a variety of huge industries such as e-commerce, internet services (search, social media, etc.), entertainment, travel, and many more.

Today the picture is not nearly as rosy. COVID-19 and China's "zero cases" approach have led to recurring, strict lockdowns that have strangled its economy and led foreign companies to pause or even begin reducing their business in the "People's Republic". While the "zero cases" policy seems to be abating, the country now faces what is likely to be a health crisis as COVID works its way through.

Even more concerning is the government's pivot to de-emphasizing economic development and re-establishing a central authority. The "election" of Xi Jinping for an unprecedented 3rd term is concerning, signaling a return to consolidation of power around a single personality. His regulatory crackdowns on technology in 2021-22 crippled many industries and hammered the stocks of tech giants like Alibaba (BABA) and Tencent (TCEHY) (among others).

Today, it's difficult to recommend China stocks. Investors can't know if or when new regulations may erase large parts of a business overnight. There have even been regulations on the U.S. side that have caused many Chinese firms to de-list from the NYSE or NASDAQ.

These are headaches we don't need. Given that, I'm eliminating all Green Screen PRC stocks from consideration. As of today, those are:

Dada Nexus (DADA)
Pinduoduo (PDD)
ZTO Express (ZTO)
Li Auto (LI)