With the first quarter coming to a close, one thing is for certain: retail investors are the talk of the town on Wall Street.
For over two months, retail investors on Reddit’s WallStreetBets chat room have focused their attention on dozens of companies that share one or two core characteristics. They were either heavily short-sold (i.e., plenty of investors were betting on a lower share price), or they happened to be penny stocks.
The vast majority of short-sellers are institutional investors or hedge funds. Since gains from shorting are capped at 100%, whereas losses are unlimited, Reddit’s retail investors have been banding together to buy shares and out-of-the-money call options to squeeze big-money institutions out of their short positions. These short-squeeze events have proven lucrative on a number of occasions.
But the fact remains that, no matter how much euphoria is built up behind a stock or a movement, operating results always matter.
With this being said, a majority of the Reddit stocks have detached from their underlying fundamentals, three of which I’d quantify as the most dangerous of all.
After monitoring the dozens of Reddit stocks driven higher by short squeezes and short-term euphoria, Canadian marijuana stock Sundial Growers (NASDAQ:SNDL) certainly fits the mold of a dangerous investment.
If there’s one positive I can say about Sundial, it’s that the company is swimming with cash. As of March 15, it had $719 million Canadian ($570 million U.S.) in cash on hand. This should be more than enough capital for Sundial to execute whatever growth strategy management has in mind. Because Sundial isn’t a bankruptcy risk, I don’t view it as the most dangerous Reddit stock. But it’s still in the top three — and for good reason.
To begin with, management has given zero regard for the company’s shareholders. Although share-based dilution has become somewhat the norm over the past four years from Canadian pot stocks, Sundial’s dilution has been nothing short of egregious. In five months, the company more than tripled its outstanding share count by issuing 1.15 billion shares. That’s not a number that can be swept under the rug, especially with the company filing a prospectus to sell up to $800 million in additional common stock via at-the-market offerings.
Despite raising a boatload of cash and erasing its debt, Sundial’s mammoth outstanding share count (1.66 billion) will make it virtually impossible for the company to generate meaningful earnings per share, or perhaps to even stay above the $1 minimum listing threshold on the Nasdaq exchange.
What’s more, Sundial’s management team doesn’t have a clear plan for its capital. That’s not encouraging from a company that’s losing quite a bit of money and growing revenue at a substantially slower rate than its peers.
In my view, Sundial shouldn’t be trading much higher than its cash value. This would imply more than 65% downside may await Sundial’s shares.
Arguably the second-most dangerous Reddit stock of all is the one that started it all: GameStop (NYSE:GME). Over the trailing year, shares of the video game and accessories company are up 4,000%, with a significant portion of those gains occurring within the past 2.5 months.
Since I said one nice thing about Sundial, I’ll do the same for GameStop. Last year, the company’s e-commerce sales skyrocketed by 191% and accounted for 30% of net sales. These figures suggest that the company’s pivot to digital gaming is gaining some traction.
I’ll add that GameStop’s $635 million in cash dwarfs its $362.7 million in total debt. We’re not talking about a company facing the threat of bankruptcy, but we’re also not dealing with a company that’s performing well, as a whole.
GameStop’s operating model was designed to be a brick-and-mortar powerhouse. It worked just fine for two decades, but the company was left unprepared by the shift to digital gaming. Even with aggressive reinvestment into e-commerce initiatives, GameStop’s losses are piling up. Last year, total sales declined by 21%.
For the time being, GameStop’s primary strategy is to close stores to reduce its expenses. Eventually, the company will slash enough of its expenses to get back in the profit column. However, expense-cutting isn’t exactly a long-term growth strategy.
With the company a good three years away from full-year profitability, by Wall Street’s estimates, my suspicion is it could lose well over 80% of its value, based on where it ended this past week.
Lastly, we have what I believe to be the unquestioned most dangerous Reddit stock of all: AMC Entertainment (NYSE:AMC).
The best thing I can say about movie theater chain AMC is that it actually began diversifying its revenue stream prior to the pandemic. Even though there are a number of streaming service options for consumers to choose from, AMC launching an on-demand digital movie service in late 2019 was a smart idea that helped to generate some revenue when its theaters were closed last year. Unfortunately, this is the only bit of good news I have to offer with AMC.
One of the more glaring issues is that its operating model appears broken, or in serious trouble. AT&T subsidiary WarnerMedia is debuting all of its films in 2021 on HBO Max the same day they’ll hit theaters. Walt Disney is doing something similar with a small number of movies on its Disney+ streaming service. AMC is either going to see its exclusivity window shrink in the future, or perhaps disappear entirely.
Even more concerning is AMC’s balance sheet. Whereas Sundial and GameStop have healthy net cash positions, AMC ended 2020 with more than $5.7 billion in debt, and has since added more debt to stave off bankruptcy. Most of the debt the company has taken on over the past year bears a double-digit interest rate. With AMC slated to lose money for at least the next three years, servicing this debt is going to be difficult.
Plus, AMC’s turnaround is almost entirely dependent on the pandemic ending. While America’s vaccination campaign has been an early success, variants of the coronavirus threaten to weaken vaccine efficacy. Without herd immunity, it’s going to be difficult for AMC to return to full strength.
Long story short, AMC Entertainment is one of very few Reddit stocks that’s a genuine bankruptcy risk. AMC might have north of $1 billion in cash now, but with more than $1.7 billion in operating losses projected by Wall Street through 2022, it doesn’t look to have anywhere near enough capital.
If I could urge retail investors to avoid one stock and one stock only, it would be AMC Entertainment.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.
View more information: https://www.fool.com/investing/2021/03/31/the-3-most-dangerous-reddit-stocks/