Some of the best investments can be the most popular. On the other hand, getting caught up in the herd -- while ignoring what's actually happening with the business itself -- can be a surefire way to leave yourself with a smaller investment than you started with.
Three of our top contributors have identified three stocks that are popular with investors right now but could also be poisonous to own. This includes computer-chip designer Advanced Micro Devices, Inc. (AMD -2.14%), small-in-size (but big-in-risk) biotech Novavax, Inc. (NVAX -3.77%), and mortgage REIT giant Annaly Capital Management, Inc. (NLY -1.36%).
If you've been considering one of these stocks for your portfolio, make sure you've studied them closely. They may be popular, but they might also be toxic.
How long can this rocket ride last?
Anders Bylund (Advanced Micro Devices): AMD sure fits the bill if you're looking for a popular stock. The chip designer inspires impressive volumes of online forum discussions, and daily trading volumes are downright crazy for a moderately sized midcap stock. This would be great if AMD were a fresh-faced upstart or a solid turnaround story in the making, and investors just couldn't help to share a near-certain ticket to big gains before the rally runs out of gas.
Unfortunately, that's not what AMD is offering here.
Share prices have risen more than fivefold over the last year. AMD is trading at price-to-sales ratios comparable to larger rival Intel, and a much richer price-to-book ratio. Again, this could make sense if AMD sported profit margins in Intel's class, or superior growth trends. But Intel remains a stoutly profitable pillar of the semiconductor industry while AMD's profit margins have been negative for years.
Yes, AMD is doing many things right for the first time since dropping former CEO Dirk Meyer like a bad habit. Current leader, Lisa Su, has righted the sinking ship to some degree and AMD is turning out competitive chips these days. One of these days, the company might even turn a profit.
But that's still more of a gamble than an investment thesis. And either way, share prices have shot up into nosebleed territory with little support from actual business results.
Priced for absolute perfection, AMD must now deliver on every bit of the promises its new Ryzen and Polaris chip architectures have been making. All it takes is one manufacturing misstep, one equally fantastic product launch from a major rival, or one mistake at the negotiating table with PC builders -- and then the gains of 2016 could evaporate in a hurry.
Stumbling without a safety net
Cory Renauer (Novavax, Inc.): Although small-cap biotech stocks can inflate your portfolio overnight, they also have a tendency to let the air out. Sticking to companies taking multiple shots on goal is a great way to protect yourself. Unfortunately, Novavax's safety net is practically nonexistent. It isn't isn't running any clinical trials with new drug candidates other than a once-failed experimental respiratory syncytial virus (RSV) vaccine.
For decades efforts to develop a vaccine to prevent RSV have come up short, and it remains a leading cause of hospitalizations for infants and older adults. The first effective vaccine could generate billions in annual revenue and send Novavax's stock soaring.
Unfortunately, Novavax's RSV candidate already stumbled once. The market hammered the stock last year after the company announced miserable late-stage trial results. In a trial with thousands of older adults, it failed to reduce the rate of infection versus a placebo.
The company had already started another large trial with pregnant women to see if it will lower infection rates of newborn infants through their first year. Positive results could lift the stock, but in the meantime, the company is quickly depleting its cash reserves. It ended 2016 with $235.5 million in cash and cash equivalents, after burning through $255.5 million last year.
Raising more equity to pay the bills would dilute shareholder value in the near term. Further out, another failure in the maternal immunization could be devastating. As much as I'd love to see the company succeed, it seems letting this stock into your portfolio could prove highly toxic.
A good company on the wrong side of a cyclical shift
Jason Hall (Annaly Capital Management, Inc.): Annaly Capital is as well-run a company as you'll find, and its 12-month dividend yield of nearly 11% at recent stock prices makes it incredibly appealing, and popular for investors chasing income.
However, because of the way the company makes a living, investors should think twice before making a big bet that the dividend will be dependable going forward. Annaly Capital makes money on the spread between what it pays for capital when it takes on debt and what it can collect in interest on the assets -- largely residential and commercial real estate debt it buys with the capital. And it's looking more and more as if we're moving from a decades-long period of falling interest rates, which had been great for Annaly's ability to grow earnings (and its dividend), to a cycle of flat-to-rising rates.
And where this could be a problem for Annaly and other REITs that focus on owning debt is that its cost of capital could increase more quickly than the rates it will be able to collect, narrowing the "spread" it gets and cutting profits. Frankly, that's a big reason its stock is yielding so much today -- the market seems to expect this will catch up to Annaly sooner or later, and the dividend will get cut.
If that happens, many of those income-chasing investors will quickly flee the stock and send it falling, adding the injury of capital losses to the insult of a slashed dividend. So before you rush into this potential dividend opportunity, don't discount the risk that it really is too good to be true.