Why King Digital (NYSE: KING) Stock Fell 27% This Week

Update: After opening at $18.94 a share on Monday, King Digital (NYSE: KING) stock has since dived 27.84% to trade at $13.93 a share on Thursday. The bloodletting really began after hours Tuesday when the Dublin, Ireland-based social game company released second-quarter earnings that sparked a more than 20% plunge.

Three bad signals in earnings fueled the sell-off, and all three are tightly interrelated.

Why King Stock Plummeted 27%

The first was the "Candy Crush Saga" maker's sales.

While earnings were in-line with Wall Street estimates, sales were not. King reported adjusted earnings of $0.59 a share on $594 million in revenue, missing consensus estimates of $0.59 a share on $608 million in revenue. Sales weren't all bad - the company's revenue did increase 30% compared to the same quarter a year earlier. And profit rose to $165.4 million, up from $125.92 million the same quarter in 2013.

Second, the company lowered its full-year outlook and gave weak third-quarter guidance, a huge reason behind KING stock's sharp decline today.

It's now forecasting third-quarter bookings of between $500 million and $525 million, and said it expects gross bookings - the total amount of cash users spend on virtual items - for the full-year to come in between $2.25 billion and $2.35 billion. Gross bookings for the second quarter came in at $611 million (under the $640 million analysts had projected).

"While our second-quarter gross bookings came in below our expectations, leading us to reduce our outlook for full-year 2014 growth rates, from a profitability perspective, the business continued to perform well, delivering adjusted EBITDA margins of 42% and generating healthy cash flows of $154 million to boost cash and cash equivalents to more than $800 million," King Chief Executive Officer Riccardo Zacconi said in the earnings statement.

Lower gross bookings points to a dangerous trend for King - one that affects the backbone of King's value and serves as the third piece of information that has fueled today's KING stock sell-off...

Slashed gross bookings mean King's number one game "Candy Crush Saga" - the company's main lifeline for cash - is quickly losing popularity.

In a conference call with investors following earnings release, Zacconi attributed declining sales to a "step down in monetization across our network" including its other game hits such as "Papa Pear Saga" and "Bubble Witch Saga." He went on to say that "Candy Crush"'s bookings peaked in Q3 2013, that the rate of decline picked up at the end of the last quarter, and that the company expected the slowdown to continue.

King's 2013 sales highlight "Candy Crush"'s impact. King reported almost $1.9 billion in revenue in 2013 (the year the game peaked), compared to $164 million in 2012, almost entirely driven by gross bookings from "Candy Crush" players.

The game has recently fallen off the list of top ten downloaded games, despite still being the second-highest grossing game on iPhone in the U.S.

Money Morning Chief Investment Strategist Keith Fitz-Gerald suspected King was a slave to a craze, and warned investors against buying KING stock before it went public on March 27.

"The first law of capitalism is to make money while the sun shines," Fitz-Gerald said. "For investors, this is probably nothing more than a fad."

At its debut, King's $7 billion valuation was nearly 2.9 times more than its projected 2014 sales at the time.

That was just one of four reasons we panned the King IPO from the get-go... (you can read all the reasons here).

This morning, King was downgraded by analysts at Barclays from an "Overweight" rating to an "Equal Weight" rating in a research report. Barclays has a $16.00 price target on KING stock, down from $24.00 - indicating a potential downside of 12.09% from the company's current price.

Meanwhile, as King flops, you can profit elsewhere - this rural telephone company just changed the rules on telecom competition, and rivals will have to react or fall behind...

Do you think King stock can turn around? What do you think of its ability to innovate new games? Let us know on Twitter @TaraKateClarke or on Money Morning's Facebook page.