Image source: Getty Images.
We'd all like to invest in the next big thing, but avoiding major mistakes is a far simpler way to produce above-average results. As Warren Buffett said, "You only have to do a very few things right in your life so long as you don't do too many things wrong." When it comes to investing, staying away from stocks that have the potential to permanently wipe out a significant portion of your hard-earned cash is a good strategy to follow.
Which stocks should be avoided? For me, GoPro (GPRO -0.57%), Chipotle Mexican Grill (CMG 0.17%), and J.C. Penney (JCPN.Q) make the list.
Hoping and praying
Image source: GoPro.
When your investment thesis boils down to hoping that entering new markets and launching new products will save a company, I think it's time to consider other options. Action camera maker GoPro has been a disaster since its holiday quarter last year featured a 31% decline in revenue, driven by weak demand for its products. Sales have continued to tumble, dropping 47% year over year during the second quarter, and the company is now consistently producing sizable losses.
GoPro is banking on a strong holiday season driven by new product launches. Its long-awaited Karma drone is set to be unveiled later this month, and the new Hero5 is expected to be launched soon. The company is expecting these products to reverse the company's fortunes. During the company's latest earnings conference call, CEO Nicholas Woodman said, "HERO5 and Karma will contribute to the largest introduction of new products in our history, all in time for what we think will be GoPro's most exciting fourth quarter ever, a quarter where we expect to return to profitability."
After a disastrous holiday season last year, I can't think of one good reason why investors should accept the company's optimistic outlook on blind faith. It's the job of management to wear rose-colored glasses. It's the job of investors to be realistic. These new products may very well return the company to profitability. But anything short of that could send the stock crashing further.
No longer special
Image source: Chipotle.
For many years, Chipotle was the undisputed king of the fast-casual restaurant industry. The company successfully convinced its customers that its food was far superior to typical fast-food fare, crafted with locally sourced, ethically raised ingredients.
This image came crashing down last year when Chipotle was rocked by a string of food safety crises. Cases of E. coli, norovirus, and salmonella popped up at Chipotle restaurants around the country, prompting an extended investigation by the Food and Drug Administration. Comparable-store sales tumbled 29.7% during the first quarter of 2016, leading Chipotle to report its first quarterly loss as a publicly traded company.
The company is trying gimmicky promotion after gimmicky promotion in an effort to get customers to come back, offering free burritos, free drinks for students, and free kid's meals. But the damage to the brand has been done, and the hard truth is that it takes a lot more time to build something up than it takes to tear it down. Winning back customers will be a struggle, and an expensive one at that.
Despite all of the issues facing Chipotle, the stock is still priced optimistically. Shares of Chipotle trade for nearly 30 times last year's earnings, which were mostly free from the negative effects of the food safety scandal. Earnings will be far lower this year, and getting back to last year's level may take years. I don't doubt that Chipotle will eventually turn things around, but I think investors are being far too optimistic. While the stock has already declined by 40% over the past year, it could still go much lower.
A risky plan
Image source: Mike Mozart via Flickr.
Much of J.C. Penney's multiyear strategy to return to profitability makes sense. The company has starting selling major appliances, creating a new revenue stream from a category that is producing solid growth. Special clothing sizes and an increased focus on beauty products should help draw in new customers, and investments in e-commerce, with the company planning to speed up its average delivery time to two days next year, will aid J.C. Penney in transforming itself into an omni-channel retailer.
The company's goal to produce as much as $500 million in net income by 2019 is ambitious, and I have my doubts that it's feasible. One of the pillars of J.C. Penney's plan is to boost its private-label and exclusive merchandise up to 70% of sales. If it works, it will drive gross margin higher. But swapping out national brands comes with the risk of driving customers away. Competitor Kohl's experienced exactly that effect when it shifted too far toward private-label merchandise in recent years.
Shares of J.C. Penney cratered a few years back after sales fell off a cliff. With the company still very unprofitable, nearly everything needs to go right over the next few years for J.C. Penney for its turnaround plan to succeed. If the company manages to hit its profitability target, something that looks unlikely to me, the stock could soar. But any shortfall could lead to more pain for investors.
