Beware These 3 Unstable Stocks
Not every popular or cheap-looking stock is a good investment. Some stocks on the U.S. market are two to two and a half times more volatile than the S&P 500 index, and a single news item can move their prices by tens of percent within a few days. The source of instability differs in each case: a debt-laden balance sheet in a cyclical industry, persistent cash burn and shareholder dilution, or dependence on partners and speculation. Which three stocks should investors watch out for, and why?
Key points
Three well-known U.S. stocks show nearly double to two-and-a-half times the sensitivity to market movements. A single news item can change their prices by tens of percent within just a few days.
Even a company with nearly $188 billion in revenue may not be a stable investment. Billion-dollar losses and exceptionally low margins can lurk behind an apparently attractive valuation.
One company increased its share count by 38% over the past year, even as its share price continued to plunge. Why might ongoing shareholder dilution be more dangerous than the share-price decline itself?
Short sellers hold more than 30% of one company's free float. Yet a single positive news item could be enough to trigger a sharp rally that may have almost nothing to do with fundamentals.
Analyst price targets suggest exceptional upside potential for some stocks. But outdated estimates, weak liquidity and problems that ordinary screeners miss may lurk behind the optimistic consensus.
Volatility is often mistaken for opportunity. A stock that moves 20% in a week attracts traders and retail investors with the prospect of quick profits. But the same dynamic works in the opposite direction, too. With volatile stocks, the difference between good and bad timing is measured in tens of percent, and investors who don't understand what causes the volatility can easily end up on the wrong side of the move.
Instability usually has more than one source. It is most often measured using beta, which expresses a stock's sensitivity to movements in the overall market. A value of 1 means the stock tracks the index, while a value of 2 means it moves with twice the average magnitude. But the number alone is not enough. It is just as important to understand why a stock is volatile. A giant company with a debt-laden balance sheet in a cyclical industry behaves differently from a company that burns cash for years and finances itself by issuing new shares, and both behave differently from a biotech stock whose price is driven more by news and short sellers than by fundamentals.
Today's selection covers exactly these three cases. All three companies have five-year betas between 1.9 and 2.5; two have short interest exceeding one-fifth of their free float, and all three will report earnings within the next three weeks. Now is the perfect time to take a closer look.