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.
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).
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 did very well for a long time. The long-term price chart of iShares NASDAQ Biotechnology Index (NASDAQ:IBB) illustrates the big picture.
Here are the current top 10 holdings of IBB.
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.
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%.
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.
If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.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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