Tag Archives: NASDAQ:GOOGL

What are the Real Risks of Stock Investing?

Summary

  • The real risk of stock investing is investors themselves.
  • It’s very common that stocks fall temporarily. When they fall, you have to determine if it’s a temporary or permanent fall.
  • If the stock of a great business falls temporarily, investors should take advantage by buying more shares.
  • Avoid buying bad stocks and bad companies. They’re two different things. As an investor, you want to avoid bad companies as much as possible.
  • You’d want to wait for a bad stock (but a good business) to become a good stock to invest in.

Investors worry about their stocks falling and resulting in money losses. But the real risk is not a stock falling temporarily. The real risk of stock investing is when stocks fall and investors sell, causing permanent losses, while the stocks may only be falling temporarily.

There’s also real risk when a stock falls permanently, doesn’t come back up, or the business behind the stock goes bankrupt.

Another real risk is when investors get a dividend cut so that they get lower dividends than they anticipate.

The Real Risk of Stock Investing is Investors Themselves

There are two common scenarios when stocks fall temporarily. During such times, there are a lot of negative sentiment surrounding the affected stocks. If stockholders can’t stomach the stock volatility and give in to fear or don’t have a clear conviction on why they hold each of their stocks, they’ll have trouble holding on to the shares.

Stocks Fall Temporarily in a Market Correction or Market Crash

A common scenario for when stocks fall temporarily is during a market correction or a market crash.

During the last financial crisis, from the peak of 2007 to the trough of 2008, Alphabet (NASDAQ:GOOGL)(NASDAQ:GOOG) stock fell about 60%, as shown in the chart below.

Source: Google Finance

However, the company itself was still making tonnes of money. In fact, on a per-share basis, earnings increased by more than 40% in each of 2007 and 2008! So, the stock was an absolute steal when it fell a lot during the crisis. At the trough, it traded at a price-to-earnings ratio (P/E) of less than 16.

Source: F.A.S.T. Graphs

The stock fell 60% because there was an excessive negative sentiment in the stock market at the time. Since Alphabet was making so much profit, which was a trend that was set to continue, the stock price decline was temporary.

Indeed, buying the stock at the low led to nearly 700% gains from $142 to $1,132 per share, which equated to annualized returns of 21.8%!

Source: Google Finance

Even if you just bought Alphabet stock at a low, you could still be sitting on very impressive gains of 17.5% per year.

Source: F.A.S.T. Graphs

Quick Investor Takeaways

Here are a few key takeaways from the Alphabet example:

  1. You need conviction to hold on to your stocks when they fall 50%, 60%, or more. A part of that comes from knowing the business and believing that the future is bright for the company.
  2. You don’t have to buy at the low. Just buying a quality business at a low will give very satisfactory returns.
  3. You need to have cash to take advantage of market corrections.

Stocks Fall Temporarily when the Underlying Companies have Setbacks

Another common scenario for when a stock falls temporarily is when the underlying company is experiencing some temporary setbacks.

For example, when Enbridge (TSX:ENB)(NYSE:ENB) first announced its merger with Spectra Energy Corp. in September 2016, the stock climbed about 11% in a few days from the CAD$53 level to the CAD$59 level.

Fast forward to today, the stock trades at below CAD$48 per share. The company took on a lot of debt for the merger to happen. There was also some short-term dilution in the stock — the company’s earnings and operating cash flow dipped meaningfully on a per-share basis in 2017.

Source: F.A.S.T. Graphs

In the near term, there’s a drag on the company due to the delays in the important Line 3 Replacement project, which makes up more than half of the company’s medium-term capital program of CAD$16 billion, and ENB now expects the project to come into service in the second half of 2020. There’s great investment in the project, but the project doesn’t increase the company’s cash flow until it completes. That’s why the Line 3 Replacement project is weighing down on the stock for now.

Enbridge’s payout ratio is forecasted to be roughly 66% of its distributable cash flow this year. So, there’s good coverage for its dividend.

The chart below shows that Enbridge has increased its dividend per share in the long run (since before 1990!) even though there were little bumps here and there.

And Enbridge currently offers a yield that’s at the high end of its historical yield range, which indicates the stock may be a great bargain today for income! One more thing — ENB aims to increase its dividend per share by about 10% next year.

Chart
Data by YCharts

In summary, I believe there’s a temporary setback on ENB stock. As the company gets closer and closer to the completion of the Line 3 Replacement project, the stock should head higher.

Quick Investor Takeaway

Investors have to determine if it’s a temporary or permanent setback when their stock holdings fall. Gaining investing experience will help you with your decisions of buying more, holding, or selling when your holdings experience setbacks.

The Real Risk of Stock Investing is Choosing a Bad Company

Notably, I didn’t say “choosing a bad stock” because a company can be good but it could be a bad stock at the moment. It’s like during the Internet Bubble, Microsoft (NASDAQ:MSFT) traded at a P/E of more than 70! It was a good company that was still profitable and continue to make more money over time, but it was a bad stock because it was super expensive.

Source: F.A.S.T. Graphs

Investors who bought MSFT stock at the peak in 1999 needed to wait until 2016 (about 16 years!) to get back to breakeven.

There’s real risk when you choose a bad company. The stocks of bad companies could end up being worth nothing in the worst case scenario when businesses file for bankruptcy. Debtholders get their money back first. What’s left of the company after (usually not much) will go to stockholders.

In a slightly better scenario, the stock falls a lot, and it takes years to recover. Maxar Technologies (TSX:MAXR)(NYSE:MAXR) may be such a company. It can be a multi-bagger if it recovers. However, it’s a super risky investment right now, and that’s why I’m not risking my money in the stock.

The company made a number of acquisitions, increased its debt levels immensely, and the acquisitions simply weren’t working out as management has planned.

At the end of the first quarter, MAXR’s debt-to-equity (D/E) and debt-to-asset ratios were 7.8 and 0.88, respectively. Its cash-flow-to-debt ratio was less than 0.7%, which means there was very low coverage of the debt with its cash flow. The company is simply too overleveraged.

Source: Google Finance

Quick Investor Takeaway

Investors should aim to invest in great businesses from different industries at a good valuation. By doing this, their overall portfolios should increase in value over time despite temporary or permanent setbacks from individual holdings.

Dividend Cuts are a Real Risk

If you bought a stock expecting its dividend to be safe, then it is a risk when it cuts its dividend.

For example, if you hold shares of Johnson & Johnson (NYSE:JNJ), you don’t expect it to ever cut its dividend. The chart below shows that JNJ’s earnings per share have been very stable and growing steadily for a long time with excellent coverage for its growing dividend.

Source: F.A.S.T. Graphs

Of course, there are situations in which investors may buy a dividend stock with the primary goal of price appreciation and view the dividend as a bonus.

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Disclosure: As of writing, we’re long TSX:ENB, GOOG, and JNJ.

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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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
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Why This Growth Stock Went Up +10% on Monday

This first appeared in the Seeking Alpha Marketplace service DGI Across North America, from which you can get real-time buy and sell alerts (and explanations) when I make moves in my portfolio.

Summary

  • NetEase up 10.4% on Monday. My position is up nearly 17% in a little over 2 months.
  • News came out that it plans to buy ~$11 billion of inventory over the next 3 years from the U.S., Europe, and Japan to sell to the Chinese market.
  • NetEase is primarily a video game publisher in China that has been diversifying into e-commerce.
  • NetEase is reasonably valued after the pop based on the consensus low-end earnings growth estimation.
  • Interested investors can nibble here to start a position, but will be safer to buy on a meaningful dip — perhaps one will occur when the company reports Q3 results on Nov 15.

Occasionally, dividendfocused portfolios need some growth to spice things up. And NetEase Inc. (ADR) (NASDAQ:NTES) is a good candidate for consideration.

NetEase stock appreciated 10.4% on Monday. In the DGI Across North America service, I gave a real-time alert and the reasoning for buying NetEase, which is now up nearly 17% in a little over 2 months.

NetEase position November 2017

Source: Author

The following quotes are excerpts from my previous article that’s available in the service.

NetEase was founded in 1997 and has been listed on the NASDAQ since June 30, 2000. Even for an investment that was made at the end of 2007 would have delivered an annualized return of 32%!

This outperformed Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL) which has delivered an annualized return of 10.8% in the period, Baidu (ADR)(NASDAQ:BIDU): 19.6%, and even Amazon (NASDAQ:AMZN): 27.2%.

NetEase is the second-largest video game publisher in China.

In 2016, NetEase generated 73.3% of its revenue from its online games.

NetEase PC games Q2 2017

Source: Company Q2 2017 presentation – Slide 6

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