By by Joseph Hogue
Gambling is a dirty word among investing professionals. The idea that you’re leaving your money up to chance is anathema to everything we believe.
Nobel-laureate Paul Samuelson even said investing should be the antithesis to the excitement in gambling with, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.”
But is there a time when it makes sense to make a bet on an investment?
We’ve all seen deep-value stocks that scream, “Buy Me!” as the shares keep falling against strong fundamentals and potential upside.
Investor sentiment can weigh on a stock’s price long after reason says to start building a position. While you might not be able to call a bottom in the price, these bets in beaten names can pay off big time. Even as the rest of the market questions your judgement, or even your sanity, sometimes taking a chance and making the calculated bet is what investing is all about.
Should You Gamble On Lottery Ticket Stocks?
Hearing Miller Tabak, equity strategist at Matt Maley, talk about Snap as a “lottery ticket” investment on CNBC last week got me thinking about similar “bets” in the market. Despite horrific price charts, sometimes fundamentals and catalysts for upside can turn a losing stock into a winning bet.
Maybe the best example of this is Apple, which was on the edge of bankruptcy in 1997 at the height of the tech boom. Despite investor pessimism, the company had a growing brand and catalysts in personal computing.
A $150 million investment by Microsoft saved Apple and it went on to be the first U.S. company to reach a $1 trillion market cap.
While few could have foreseen the cash infusion by Microsoft, fundamental and brand value at Apple was evident. Another example, Facebook rose to $38.23 on its first day of trading in 2012 only to plunge 54% to $17.73 in less than four months.
The world’s largest social network struggled with making money on over a billion users but was still growing. It just needed to convince investors of the fact.
Less than six years later, the shares have risen more than eight-fold from that low.
That’s not to say that you can just throw darts at a list of penny stocks and hit your next bullseye investment. The signs of a great lottery-ticket stock are companies with a balance sheet that can survive short-term sentiment and catalysts for growth.
Finding Great Lottery Ticket Stocks
Any “lottery ticket” stock is going to be controversial. The very definition of high-risk, high-return means that many in the market will be betting against you.
There are a few things I look for to tip the odds in my favor.
First, I look for companies with a long track record that have fallen recently on management missteps or a change in the market for their products. Brand value is enduring and can be saved if bad management is sacked and the company’s fortune can be turned.
General Electric (GE) is perhaps the most contested lottery ticket stock right now having lost 61% from its 2016 peak. The iconic industrial conglomerate lost its place as the last original member of the Dow Jones Industrial Average after it was replaced earlier this year.
The company ran into multiple challenges with a secular downtrend in its Power division and management missteps in acquisitions. Remaining liabilities around GE Capital and underfunded pension costs weakened cash flow.
The board recently replaced CEO John Flannery with Larry Culp, formerly head of healthcare conglomerate Danaher. I personally believe that Flannery made many difficult decisions to secure cash flow and put the company back on track but it wasn’t fast enough for investors or the board.
GE is likely to remain committed to Aviation, Power and Renewable Energy after scaling down or selling off significant portions of the company. While renewables are currently facing overcapacity, the future holds much more potential. Aviation is where the company’s real brand and power remains with scale advantage and switching costs for customers. There is a GE engine in two-of-three commercial flight departures.
Shares have rallied on the change in leadership and Nicholas Heymann of William Blair estimates the sum-of-parts valuation between $14.60 to as high as $22.30 per share. Cash flow is still a problem, but, if the company can maintain the dividend while turnaround plans are cemented, the shares offer a 3.8% yield while investors wait for this ticket to pay off.
Long-term catalysts are also important, not just for lottery stocks. The market is notoriously short-sighted and a few bad quarters can sink a stock even against solid long-term potential. The company may have new assets just being developed or the industry itself may be emerging.
Snap (SNAP) investors hoping to get in on the next social media superstar have been disappointed as the shares shrink from the 2017 IPO price of $17 and a $24 peak to just $7 per share. The platform has faced slowing user growth and has yet to fully monetize traffic.
A second-quarter decline of 2% in daily active users (DAU) versus the first quarter scared remaining investors even though the 188 million users was 8% higher versus the same quarter last year. Average revenue per user (ARPU) increased 33% from the prior year and led to a 44% increase in revenue for the quarter.
Brian Wieser, analyst at Pivotal Research, floated the idea recently that Snap could buy its shares back in a go-private deal as a solution to its public problems. According to the analyst, ongoing experimentation with new applications is broadening the user base and the company has yet to monetize its full potential.
Nearly a fifth (19%) of the shares are sold short, but there’s reason to believe catalysts could help surprise to the upside and squeeze short-sellers out of the trade. Demographics for users skew younger with most in the 18 to 24 age group and setting growth to continue as the market enters years of stronger income.
Monetization has been an issue for every social media platform from Twitter to Facebook. All have found a way to make money off hundreds of millions of users and have seen shares bounce from lows. Revenue at Snap is expected to grow over 30% annually over the next several years to $2.9 billion in 2021 versus just $1.2 billion this year.
Innovation and potential in its lenses, filters and the recently announced Snap Originals all could reinvigorate growth. The platform has a strong user base from which it can grow and may benefit as users sour on larger platforms like Facebook and Twitter.
Risks To Consider: Just like the Powerball, lottery ticket stocks could ultimately return nothing. Investors should limit their bets in these stocks to no more than they are willing to risk.
Action To Take: Buy your ticket to shares of companies with the potential for a dramatic turnaround and triple-digit stock gains based on fundamentals and catalysts for growth.
Disclaimer: The author has no position or business relationship in any stock or company mentioned in this article. The author is not receiving compensation for this article. This article is intended for informational and entertainment use only, and should not be construed as professional investment advice.