Are High Return Investments Too Good to be True?

Who doesn’t want high returns on their investments? However, when something sounds too good to be true, it probably is. More specifically, when certain stocks deliver excellent returns, ask yourself what’s the risk behind them.

coins stacking higher and higher with plant behind each stack indicating growth of money

Here are some examples.

High Return Tech Stocks

Shopify (TSX:SHOP)(NYSE:SHOP) has got to be one of the highest return tech stocks out there. Here’s a chart that shows its total returns since inception compared to other big tech names.

Yes, Shopify stock kicked the butts of the FANG stocks, Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN), Netflix (NASDAQ:NFLX), and Alphabet (NASDAQ:GOOGL)(NASDAQ:GOOG).

SHOP Chart

SHOP data by YCharts

However, Shopify’s valuation is super duper expensive. At about US$200 per share, it trades at a blended P/E of about 500 and a PEG ratio of about 20.

Compare that to:

  • Facebook’s P/E of about 23.2 and a PEG ratio of about 1.5 at US$175 per share,
  • Amazon’s P/E of about 83.6 and a PEG ratio of roughly 1.4-2.8 at US$1850 per share,
  • Netflix’s P/E of about 120 and a PEG ratio of 2.4-3.9 at US$361 per share, and
  • Alphabet’s P/E of about 27.3 and a PEG ratio of 1.5-1.9 at US$1208 per share for GOOGL.

Surely, Shopify is growing at a super fast rate. For example, revenue growth was 59% in 2018. However, because of its astronomical valuation, it’s especially subject to an especially huge drawdown when we experience a market meltdown.

By the way, I don’t categorize the little correction we had from October to December 2018 as a market meltdown. In that period, Shopify fell from a high of about US$168 to a low of about US$120 for a drop of 28%. Imagine what a real market meltdown can do to Shopify stock (at least in the short term).

Biotech Stocks

Biotech stocks did very well for a long time. The long-term price chart of iShares NASDAQ Biotechnology Index (NASDAQ:IBB) illustrates the big picture.

Source: Google Finance with author annotatio

Here are the current top 10 holdings of IBB.

Source: iShares

A quick look at the 5-year price charts of the top 3 holdings of IBB below shows that it’s pretty much a hit or miss if you buy individual stocks in the biotech sector.

Source: Google Finance
Source: Google Finance

Though Amgen (NASDAQ:AMGN) has proven to be above-average stable, one has got to question whether it makes sense to pay a 13.7 P/E of a 5-year estimated earnings per share growth rate of 2-5.5%.

Source: Google Finance

Investor Takeaway

Investors should watch out for high return investments that have done well recently for as long as the last few years. Ask yourself what’s driving their growth, whether the growth could last, or if the stock is too expensive, for instance.

For more predictable investing returns, consider value and dividend investing instead.

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Disclosure: As of writing, I’m long SHOP, FB, AMZN, GOOG, and CELG.

Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.

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