Why Dropbox Inc. Stock Took a Hit on Friday

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What happened

Shares of cloud storage company and new IPO Dropbox Inc. (NASDAQ: DBX) are getting -- well, they're getting dropped like a hot potato this morning, after the stock was rated "reduce" by analysts at Nomura Instinet.

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Citing "consistently low" penetration of the storage market, "extremely low" rates of converting free users to paying subscribers, and other flaws, Nomura announced its first rating on Dropbox today: a $21 price target and a rating of "reduce," or basically a soft "sell" recommendation.

Dropbox stock was down 8.9% as of 1:40 p.m. EDT in response.

So what

Believe it or not, Nomura actually likes Dropbox as a company, noting that the company is a "top player" in online backup storage and workplace collaboration in a note covered on TheFly.com this morning. Nomura believes the company poses a "staunch" competitive risk to larger internet storage businesses, including Microsoft's (NASDAQ: MSFT) OneDrive, Alphabet's (NASDAQ: GOOGL) (NASDAQ: GOOG) Google Drive, and Apple's (NASDAQ: AAPL) iCloud.

But although Dropbox may be able to drive down prices and reduce the profitability of its rivals, that doesn't necessarily mean that investors in Dropbox will profit. Nomura warns that it sees "significant downside" in Dropbox stock.

Now what

And to be honest, I see the same risk. Dropbox has succeeded in growing its business mightily, with revenue nearly doubling from 2015 to 2017. It's even made progress toward profitability, cutting GAAP losses from $326 million in 2015 to "only" $112 million last year. And of course, the company is generating quite a load of cash -- $305 million in positive free cash flow, which is certainly a point in Dropbox's favor.

Still, at a valuation of $13.2 billion, Dropbox is trading for more than 43 times trailing free cash flow, and the only prediction for its growth currently found on S&P Global Market Intelligence is calling for Dropbox's profits to grow at a meager 8% annual rate over the next five years. That's a lot to ask investors to pay, and for not much growth.

Nomura's advice to reduce your exposure to the stock seems like sound advice.

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