Many investors are content with investing in low-risk, established industry juggernauts paying out nice dividends, but some investors occasionally want to spice up their portfolio with riskier bets that have potential to be major outperformers over the long haul if things go their way.
Two of these riskier yet potentially more promising bets are Twitter (NYSE:TWTR) and Tesla (NASDAQ:TSLA). Though the two companies have almost nothing in common, investors in both stocks are hoping the right events will unfold so as to unlock major business growth and ultimately help each stock outperform the market.
A turnaround bet
Twitter investors have been concerned about the social network's prospects since user growth halted in 2015 and revenue growth subsequently slowed and eventually turned to a decline. While Twitter's growth in monthly active users has resumed, the growth is slow. In Twitter's most recent quarter, users increased by 5% year over year but were flat sequentially.
Co-founder and CEO Jack Dorsey, who was recruited back to Twitter in late 2015, is on a mission to reverse Twitter's slowing user growth and its declining revenue. The company has been making product changes in an effort to improve both the user experience and advertising products for its advertisers, hoping this can reverse Twitter's fate. And it could be argued that these changes are beginning to take effect.
While growth in Twitter's monthly active users during Q2 was unimpressive, its 12% year-over-year increase in daily active users was notable -- and this marked the third quarter in a row Twitter was able to post double-digit growth in this key metric.
Further, though Twitter's second-quarter revenue was down on a year-over-year basis, the company insisted in its second-quarter report that its underlying business fundamentals are improving. Management said this was evident by improvement in its year-over-year revenue comparisons. In Q1, revenue was down 8% year over year. But revenue fell 5% year over year in Q2.
This turnaround won't be easy. With a negative 20% net margin in its most recent quarter, Twitter will have to simultaneously improve its product while finding a path to profitability. But Twitter's undisputed relevance as a source of news and as a tool for influencers should protect Twitter from financial turmoil, giving the company the staying power it needs to work through its troubles.
A growth bet
Unlike Twitter, electric-car maker Tesla doesn't have a growth problem. Not only are Tesla's trailing-12-month vehicle unit sales up 61% year over year, but the company also has more demand for its cars than it can handle. Hundreds of thousands of consumers have made deposit-backed reservations for the Model 3, and the reservation count continues to grow.
Tesla stock's problem is its valuation. The stock trades at a whopping 5.4 times sales. This compares to an industry average price-to-sales ratio for automakers of 0.5. This valuation is particularly surprising when investors consider that Tesla has been burning through cash at an increasing rate recently. Its negative trailing-12-month free cash flow trend has worsened substantially ahead of the Model 3's production ramp-up. Trailing-12-month negative free cash flow is a mind-boggling $3.15 billion.
But Tesla is anticipating that its Model 3 will more than justify its recent cash burn as it brings greater economies of scale to its business. Considering the significant demand shown for its Model 3 even as the company does very little to market the vehicle, management expects the Model 3 to contribute as much as $30 billion in annual revenue after it ramps up the vehicle's production.
Further, Tesla expects that by next year the Model 3 will boast a lucrative 25% gross profit margin, in line with the profit margin of its pricier Model S and Model X. A 25% gross profit margin on a $30 billion vehicle program would not only justify today's stock price, but it would further fortify Tesla's leadership position in the fast-growing nascent market of fully electric vehicles.
Investors in both Twitter and Tesla are certainly taking on some notable risk. But if things go well, a position in either of these stocks could prove to be very rewarding over the long haul.