Popular stocks are expensive. An expensive stock can certainly produce market-beating returns if the underlying company performs well, but missing expectations can send the stock tumbling. Here's why Twitter (TWTR), Advanced Micro Devices (AMD 0.69%), and Mattel (MAT 0.67%) could devastate your portfolio.
Nothing to sing about
Rich Duprey (Twitter): Shares of Twitter are up 34% over their recent lows and are 10% higher in 2017 so far, but the problems are legion with the short-form social media platform, and investors would be wise to avoid it.
Twitter user growth has largely stalled causing revenues to flag, as well. Advertisers are seemingly becoming leery about the value of the service as revenues from that avenue rose just 6% last quarter. In fact, the whole operation looks as though it's seizing up, as growth across any metric is, by and large, in the single digits -- hardly the kind of results you'd expect out of a tech company.
Image source: Getty Images.
But there are deeper problems, too, considering Twitter generates some $2.5 billion in revenues annually, which isn't all that shabby. But generating those revenues is apparently a very expensive business -- some $1.2 billion, or almost half its sales. And last quarter, the company announced that it needed to restructure its operations, which meant firing 9% of its workforce.
Of course, there are also the usual complaints about the online bullying that occurs on the social media platform, in addition to the rabid flash-mob attacks that can instantly appear if you fall on the wrong side of the issue. And Twitter is having a growing credibility problem as more and more of its accounts are found to be operated by bots.
According to recent research, there could be a network of almost 1 million bots controlling accounts on the site. While Twitter actively tries to monitor and prevent such accounts from existing, it points to some underlying problems that may create unease with its value.
Earnings are due out very soon, so we'll get to see in which direction Twitter is headed, but there's no reason to think it's about to reverse course now, and will likely only reveal a further deceleration in its growth path.
Priced for perfection
Tim Green (Advanced Micro Devices): Shares of AMD quadrupled in 2016 as investors bought into the story that new products would return the company to its former glory. Ryzen, AMD's highly anticipated PC CPU, will be arriving in early March. Vega, a high-end GPU gunning for NVIDIA, is expected to be available sometime during the second quarter.
The rally in AMD shares has so far been based mainly on hope. The company is still losing money, and its revenue is far below peak levels. Both Ryzen and Vega have a lot of potential, and AMD's deal with Google to put its server GPUs in the cloud is a good first step in catching up with NVIDIA in that area. But now, AMD needs to deliver.
AMD's market capitalization has reached about $12.3 billion, up from less than $2 billion at the beginning of 2016. In AMD's best year in the past decade, 2011, it earned $491 million of net income. AMD stock trades for 25 times that peak number, despite the company losing money in each of the past five years.
Ryzen and Vega, both high-end products, can certainly drive AMD's margins higher. But the market is pricing in something close to the best-case scenario. Absolutely everything must go right for AMD. Anything short of that could spell disaster.
Signs point to a stalled turnaround
Beth McKenna (Mattel): A popular stock -- especially among income investors -- that could prove toxic to investors' portfolios is toymaker Mattel, best known for making the iconic fashion doll, Barbie. Some of its other well-known brands are Fisher-Price, Match Box, Hot Wheels, and American Girl.
Mattel stock's long-term trajectory was solidly up through 2013. Declining Barbie sales then resulted in the stock dropping through late 2015. The company's turnaround efforts started showing signs of success beginning in the fourth quarter of 2015. Coupled with Mattel's generous dividend, these signs caused many investors to dive in, pushing the stock up considerably from its trough in 2015 into 2016.
The dividend recently got juicier -- but not for a good reason -- and is now yielding 5.9%. This increase was due to the stock's nearly 18% plunge in late January after Mattel reported weak fourth-quarter 2016 earnings.
Prime rival Hasbro has been significantly outperforming Mattel on both the business and stock-performance fronts. Data by YCharts.
The fourth quarter is critical for toy retailers because it includes the holiday period. Mattel's net sales declined 8% as reported, and 6% in constant currency, while adjusted earnings per share dropped 20%. Excluding sales from Disney Princess and Frozen -- Mattel lost this lucrative doll license to Hasbro in 2016 -- gross sales were flat as reported, and up in the mid-single digits in constant currency. So Mattel has done a nice job in closing the revenue gap created by the lost Disney license.
However, two metrics were quite concerning and point to continued struggles ahead. First, Barbie sales declined 2%, as reported, and were up 1% in constant currency. Increasing Barbie sales is the cornerstone of Mattel's turnaround plan -- and these metrics suggest the turnaround has stalled. Second, the company's decent showing on the revenue front came at a price: Gross margin decreased 320 basis points, driven mainly by increased discounting, as well as currency headwinds.
As to that fat dividend, it's not infinitely sustainable. Mattel's trailing-12-month cash dividend payout ratio (dividends paid/free cash flow) has exceeded 100% throughout 2016. This means it's paying out more in dividends than it's generating in free cash flow.
One caveat to my opinion that Mattel stock could prove toxic -- the stock could get a lift if market chatter about a merger between Mattel and Hasbro comes to fruition. But investors shouldn't buy the stock of a company based solely on merger and acquisition rumors.
