Sometimes, stocks that seem like great investments can go bad. Companies with good numbers or a strong story can have flaws that aren't readily visible to most investors. Even good companies can hit roadblocks, or situations where there's a lot more at risk than is apparent.
We asked three of our Fool contributors to name companies that are popular with investors but stand a chance of turning toxic. Here's why they're concerned about Tesla (NASDAQ:TSLA), Verizon Communications (NYSE:VZ), and Teva Pharmaceutical Industries (NYSE:TEVA)
Make-or-break moment for a market favorite
John Rosevear (Tesla): Few companies have generated the excitement among investors that Tesla has over the last several years. There are good reasons to be excited: CEO Elon Musk is a charismatic leader with big ideas; Tesla's cars are a step ahead of the big automakers' in several important ways; and the company's growth potential (in cars, in solar panels, in batteries) seems nearly limitless.
So why might Tesla prove "toxic"? It's because the company is at a genuine make-or-break moment. There's a real risk that things could go awry over the next year, and I don't think investors have properly recognized that risk.
Tesla's valuation rests in large part on the assumption that it will become a mass-market automaker, selling hundreds of thousands or even millions of vehicles year after year. To get there, its upcoming Model 3 has to be great -- and here's the thing: It has to be great in some ways that Tesla's current vehicles aren't.
That's where the risk lies. There's a lot to like about Tesla's current products, the Model S and Model X. But as even most Tesla fans will acknowledge, the truth is that both have weaknesses in their designs that show Tesla's inexperience as an automaker. That hasn't been a problem for Tesla so far: Its early adopter fans have been mostly very willing to forgive things like iffy seats, crooked panel gaps, and dodgy door handles in order to be first with Tesla's genuinely impressive whiz-bang technology.
But this is the moment where Tesla has to go beyond the early adopters and establish that it can sell vehicles to hundreds of thousands (eventually, millions) of buyers every year. Mass-market car buyers might love Tesla's tech, but if the Model 3's fit and finish, comfort, and reliability isn't up to Toyota or BMW standards, then the tech might not be enough. That will be especially true once the big automakers start to launch credible electric rivals to the Model 3, as they will -- soon.
So here's why Tesla could turn toxic: There's a real risk that the Model 3 will fall short of the quality and finish expectations that mass-market car buyers have come to expect. If it does, then Tesla will have a lot of trouble sustaining the pace of sales its investors expect, and its stock price will suffer accordingly.
Big bets and tough competition
Reuben Gregg Brewer (Verizon Communications Inc.): Verizon Communications is one of the largest telecommunications companies in the United States. It sports a fat 4.7% yield backed by 10 years of dividend increases. You'd think Verizon would be an easy stock to love as the world goes increasingly mobile. But I have a couple of concerns.
My first is Verizon's push into content. The goal appears to be expanding its reach from simply supplying the cellular connection that allows content consumption to also controlling at least some of the content that's consumed. However, Verizon is going about it by acquiring internet companies, like AOL, that have struggled after finding early success. Buying second-rate assets in the hope of a business resurrection isn't a great plan in my book. It's going to take a lot of cash to turn these businesses around, or -- my bigger fear -- the effort will be a complete waste of time and shareholders' money.
My other concern is the resurgence of unlimited data plans, increasingly at very low prices. In fact, my wife and I just switched from metered plans at Verizon and AT&T, respectively, to a competitor offering unlimited data for the same or better prices. Verizon and AT&T have no choice but to compete with smaller, more aggressive cellphone companies because there's little product differentiation today. In my mind, this industry dynamic puts Verizon at the mercy of its most desperate competitors at a time when it's making risky investments that may not pan out. That's a recipe for disaster in my book.
Too many problems
Keith Speights (Teva Pharmaceutical Industries Ltd.): At first glance, you might think that Teva is a great drug stock to add to your portfolio. The company experienced a solid boost to revenue last year. Teva stock appears to be priced inexpensively, with shares trading at less than seven times estimated earnings. And we can't forget Teva's dividend, which currently yields over 4%.
The true picture for Teva isn't nearly as good as those facts indicate, however. While the company did make higher revenue in 2016, its earnings sank. That low stock valuation reflects expectations that Teva's earnings challenges won't be fixed anytime soon. As for the dividend, the drugmaker returned a much higher amount of money to shareholders through dividend payments than it made in profits.
Teva's biggest challenge right now is that its key patents for Copaxone 40 mg/mL have been invalidated by a U.S. District Court. The multiple sclerosis drug is Teva's top seller, contributing more than 19% of total revenue.
On top of all this, Teva is searching for a new CEO. Former CEO Erez Vigodman left the company in February. His resignation followed the departure of Sigurdur Olafsson two months earlier. Olafsson had led Teva's generic-drug business.
Don't be tempted by the cheap valuation and high dividend yield. Teva might eventually get its house in order, but for now the best course of action is to stay away.