The Reddit-fueled short squeezes of GameStop (GME -4.42%) and other heavily shorted stocks earlier this year thrust the idea of "meme stocks" -- equities that get aggressively promoted on social media platforms -- into the broader market's spotlight.
Some of those meme stocks actually have solid underlying businesses that could allow them to resist a market downturn. However, there are plenty of others with businesses that can't possibly support their frothy valuations. Let's take a look at two meme stocks that will likely burn their shareholders the next time the market stumbles.
1. Naked Brand
Shares of Naked Brand Group (NAKD), a New Zealand-based retailer of intimate apparel and swimwear, surged from about $0.07 last October to an all-time high of $3.40 in late January. Nearly everyone who chased that rally and hung on got burned -- the stock now trades at about $0.77 per share.
Image source: Getty Images.
Naked's rally had nothing to do with its fundamentals. It was identified as a short squeeze target on Reddit, and its name was cited in discussions about "naked shorting" -- the illegal practice of shorting a stock without borrowing it first. Those discussions inexplicably evolved into a movement to promote the stock on Reddit, which caused it to rally alongside GameStop and other meme stocks in January.
However, Naked Brand's underlying business is a mess. Its revenue declined 20% to $58.5 million in its fiscal 2020, which ended in January 2020, and its net loss widened from $32 million to $33.9 million. It hasn't released its annual report for fiscal 2021 yet.
Over the past year, Naked exited the U.S. wholesale market, reduced its presence in Europe, divested its Bendon brand, and expanded its e-commerce platform. However, it seems doubtful those turnaround efforts will work when bigger players like L Brands' Victoria's Secret are still struggling.
Naked capitalized on the Reddit-fueled rally to sell $50 million worth of shares at $1.40 apiece in January, followed by another $100 million private placement sale in February at $0.93 per share. It claims the proceeds will be used to fund its e-commerce expansion, but it's still ridiculously overvalued right now with a market cap of nearly $500 million -- or 8 times last year's sales.
2. Koss
Shares of Koss (KOSS -1.15%), a headphone maker that got its start more than 65 years ago, had traded below $5 for years but surged to an all-time high of $127.45 in late January amid a Reddit-fueled short squeeze.
But just like Naked, anyone who chased Koss' rally and didn't get out in time incurred a loss -- and possibly a massive one -- as the stock price dropped back to the mid-teens. The correction should not have surprised anyone, since Koss' annual revenue has fallen for four straight years.
Image source: Koss.
Koss' revenue declined by 16% to $18.3 million in its fiscal 2020, which ended in June, and it posted a net loss of $500,000. It has been unprofitable for three of the past four years.
Koss' problems are easy to spot: The low-end headphone market is commoditized, and the company doesn't wield much pricing power against high-end market leaders like Sony or Bose.
On the bright side, Koss' revenue rose 6% year over year to $10.1 million in the first six months of its fiscal 2021, thanks to its rebounding sales in the U.S. and Europe, higher online sales, and the impact of the stay-at-home trend. Koss also generated a net profit of $600,000 during that period, though most of that ($500,000) came from a forgiven Small Business Administration loan that it took out during the pandemic.
Koss' growth could stabilize this year, but the company is still valued at nearly $140 million -- or 8 times last year's sales. That high price-to-sales ratio would be more appropriate for a high-growth tech stock than a struggling headphone maker.
That's probably why Koss' executives, directors, and even members of the Koss family dumped more than $44 million worth of shares in late January before the stock price plunged back to earth.
Do your own homework
It might be tempting to follow the crowds into the meme stocks being promoted on Reddit or TikTok instead of doing your own due diligence, but it's dangerous to blindly chase those rallies. Naked and Koss are clearly two of the worst offenders, and investors who are hoping their stocks will rebound are more likely to be sorely disappointed when they get crushed in the next market crash.
