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Motley Fool Issues Rare “All In” Buy Alert
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Over the long-term, the stock market is a wealth-building machine. No matter how many corrections and bear markets are thrown Wall Street’s way, each of the major indexes eventually puts notable downside moves in the rearview mirror.
However, just because the major indexes increase in value over time, it doesn’t mean all stocks will be winners. In fact, a study from finance professor Hendrik Bessembinder of Arizona State University showed that a little over half of the 26,000 stocks he examined lost investors money between 1926 and 2015.
While it can sometimes be tough to spot these potential portfolio land mines, others, at least in my view, stick out like a sore thumb. What follows are four stocks that I wouldn’t buy with free money. Note, this isn’t me advocating for anyone to run out and short-sell these companies. Rather, I’m suggesting completely avoiding putting money to work in these stocks… period.
Image source: Getty Images.
Let’s get the jaw-dropper out of the way. The first widely held stock I wouldn’t buy, even with free money, is electric-vehicle (EV) manufacturer Tesla (TSLA -2.44%).
To clear the air, Tesla wouldn’t have risen to a greater than $1 trillion valuation if it wasn’t doing something right. It’s the first automaker to build itself from the ground up to mass production in over five decades, and looks to be on pace to deliver north of 1 million EVs in a year for the first time. The company has also decisively pushed into recurring profitability.
But there are two red flags that have me wanting nothing to do with Tesla. To begin with, while CEO Elon Musk is a visionary, he’s become a significant liability to the company. Not only is his potential takeover of Twitter a distraction, but he has a terrible habit of overpromising and underdelivering. You’ll note that’s the opposite of what strong leaders do.
For example, Musk pledged to have 1 million robotaxi on the road by the end of 2020. That’s been pushed back to 2024. The electric Semi that was unveiled in late 2017 still hasn’t reached production. Promises of higher level full self-driving are perpetually one year away. The Cybertruck? It was pushed back a year, too. Musk’s inability to deliver on his visions in a timely manner is concerning for a company with a premium valuation.
The other issue is that Tesla’s competitive advantages are unlikely to last. Legacy automakers have deep pockets and are already catching up to Tesla with regards to battery capacity, range, and power. It’s incredibly difficult to envision Tesla supporting a forward price-to-earnings (P/E) ratio of 54.
The second stock I’d suggest avoiding like the plague, even with free money, is Hong Kong-based fintech stock AMTD Digital (HKD -47.65%).
If you thought the meme stock-based short squeezes of January-February 2021 were amazing, let me introduce you to recent initial public offering (IPO) AMTD Digital. The company priced its 19 million ADR shares at just $7.80 prior to its IPO in mid-July. But in a span of eight trading days between July 22 and August 2, shares of the company skyrocketed from sub-$20 to (drum roll) a peak of $2,555 a share. At its intra-day high, AMTD Digital had a market cap of well over $400 billion and had surpassed Nvidia to become the ninth-largest publicly traded company in the U.S.
If you’re wondering why it rallied, your guess is as good as mine. With only 19 million shares outstanding, a relatively small number of shares has the potential to send low-float stocks into the stratosphere — at least temporarily. Last week, only 1,051,300 cumulative shares of AMTD Digital changed hands, yet its share price vacillated between $278.51 and $2,555.30.
If the volume data isn’t enough to demonstrate that this move isn’t sustainable, just pull up the company’s S-1 prospectus filed with the Securities and Exchange Commission. In 2021, AMTD Digital brought in $25.2 million in sales and generated a $22.1 million profit. If you thought Wall Street scoffed at paying a 60 times sales multiple on high-growth tech stocks in early 2022, imagine how they’ll feel about paying 5,293 times sales for AMTD Digital, as of its close on Aug. 5, 2022.
This looks like a classic low-volume pump-and-dump scheme that will end poorly for those involved.
Image source: Getty Images.
Although history doesn’t repeat itself on Wall Street, it often rhymes. On Friday, Aug. 5, another Hong Kong-based financial services provider, Magic Empire Global (MEGL -89.47%), made its public debut and, on reasonably low volume, ascended to the heavens.
Magic Empire priced the 5 million ADRs it planned to sell at $4 per share prior to its debut. You’ll note this is an even smaller share amount than the 19 million ADRs issued by AMTD Digital. With only 545,371 share changing hands on its IPO day, Magic Empire saw its share price hit a high of $235.95 and end at $97. For what it’s worth, shares practically doubled again in after-hours trading on Friday, pushing the company’s valuation to $3.8 billion.
According to information found in the company’s S-1 prospectus, Magic Empire brought in $2.16 million in total revenue last year and generated $202,398 in net income. Before I dive into how ridiculous its valuation is, I believe it’s important to note that revenue declined 17% in 2021 from the previous year, while net income fell by more than 60%. Magic Empire’s year-over-year sales decline is primarily related to collecting nearly 20% less in IPO sponsorship service revenue in 2021.
Taking the company’s after-hours move to $192 into context places it at 1,757 times sales in 2021 and gives it a trailing P/E ratio of almost 19,000! That’s simply not sustainable for a provider of corporate advisory services and underwriting that endured a drop-off in sales and profit in the previous year. Even though Magic Empire Global has an exceptionally small float, I would expect its share price to be cut substantially in the quarters that lie ahead.
The fourth and final stock I wouldn’t buy with free money is Redbox Entertainment (RDBX -14.22%). Redbox is best-known for its self-service kiosks that allow patrons to rent or purchase DVDs and Blu-ray discs.
Redbox is a relatively low-float stock that’s been embraced by retail traders over the past three months. Their fascination with Redbox has to do with the company’s relatively high short interest. As of July 15, 2022, 2.25 million shares (19.4% of the float) were being sold short.
A “short-seller” is someone who benefits if the underlying value of a security goes down. While the maximum gain for short-sellers is 100% (i.e., a stock can’t go below $0), their losses are, theoretically, infinite. The meme stock investors targeting Redbox are angling for a short squeeze, which is a very short-term event that causes short-sellers to run for the exits and can send a stock’s share price “to the moon.”
However, there are two really big issues with Redbox that should make it off-limits for investors. First, the advent of streaming has weighed heavily on the kiosk-based operating model that, at one time, allowed Redbox to thrive. Even though Redbox has its own on-demand streaming service, the company continues to lose quite a bit of money.
Arguably the bigger problem is that, on May 11, 2022, Redbox agreed to be acquired by Chicken Soup for the Soul for a fixed price of 0.087 Chicken Soup for the Soul shares for every Redbox share. Last week, Chicken Soup for the Soul shares ended at $10.84. This means the current buyout price for Redbox equates to just $0.94 a share. In other words, Redbox is going to lose more than 80% of its value if and when this deal closes.
Sean Williams has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia, Tesla, and Twitter. The Motley Fool has a disclosure policy.
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