What a year it's been for Wall Street. Panic and uncertainty surrounding the coronavirus disease 2019 (COVID-19) pandemic sent equities to their fastest and steepest bear market decline in history during the first quarter. But records were broken on the way back up, too, with the benchmark S&P 500 taking less than five months to reclaim fresh all-time highs.
Though volatility can be scary, it's almost always a welcome sight for long-term investors. That's because it allows patient investors to buy into high-quality companies at a perceived discount.
Image source: Getty Images.
However, volatility also attracts inexperienced investors who hope to make a quick buck in the stock market. Rarely, if ever, does the short-term strategy of chasing volatility via penny stocks work out well.
Take online investment platform Robinhood. Known best for offering free trades and gifting a small parcel of stock to users when they open accounts, Robinhood has primarily attracted millennial and/or novice investors. A quick glance at the online platform's leaderboard (i.e., the stocks most-held by members) is telling. Though you'll find a few high-quality long-term holdings, penny stocks and generally awful companies seem to satisfy many Robinhood investors.
There are three exceptionally popular holdings on Robinhood in particular that could lose 50% or more of their value.
A Tesla Model S plugged in for charging. Image source: Tesla.
Tesla
Although it's possibly the hottest stock on Wall Street at the moment, and it's the eighth-most-held one on Robinhood, electric-vehicle (EV) maker Tesla (TSLA 1.94%) has a mind-boggling valuation.
There are reasons for investors to be optimistic about Tesla. The company has surpassed delivery expectations in 2020 thus far. CEO Elon Musk is highly motivated and vested in the company's future, owning roughly 21% of Tesla's outstanding shares. It certainly doesn't hurt that Tesla caters to a more affluent group of auto buyers who are less likely to alter their consumption habits during economic hiccups.
But if you ask me if this group of catalysts is worth a $382 billion market cap, my answer is a resounding no.
What we've witnessed from Tesla in 2020 is a complete wipeout of what had been an unrelenting short position in the company. We've also seen short-term investors piling into the stock because they fear missing out. Even the company's announced 5-for-1 stock split has added almost 50% to its share price. None of these catalysts has any true fundamental bearing on Tesla.
Tesla has managed to create a mass-produced EV, and at one time it had early-mover advantage in this space. However, the gap in battery performance between Tesla and its peers has shrunk. Numerous well-funded competitors with decades of history behind their brands are now producing high-performance EVs. In 2018, Ford announced plans to invest $11 billion in EVs by 2022, while General Motors offered plans this March to spend $20 billion on EVs and autonomous vehicles through 2025. In other words, Tesla's runway is getting awfully crowded.
Emotional investing has proved time and again that it can only carry a company's valuation so far, and Tesla's share price could be significantly lower over the next six to 24 months.
Image source: American Airlines.
American Airlines Group
Another very popular Robinhood stock that could face some serious future downside is American Airlines Group (AAL -1.34%).
Whereas Tesla has a feel-good story behind its ascension, it's unclear why Robinhood investors have anointed American Airlines as the fifth-most-held stock on the platform. It may look "cheap" simply because its share price has retreated to nearly an eight-year low, but there's pretty much nothing redeeming about airline stocks -- and especially American Airlines -- at the moment.
The obvious knock against the airline industry is that we have no clue when passengers are going to return to the skies at pre-pandemic levels. A coronavirus vaccine may encourage travelers to start flying again, but it could be years before we have any semblance of normalcy for airlines. That's a big problem for a capital-intensive, low-margin industry that simply cannot sustain losses for long periods.
With regard to American Airlines, it's been able to raise cash through debt offerings. While this staves off any near-term possibility of bankruptcy, it's also ballooned the company's total debt to $40 billion. Even if American Airlines pulls through this pandemic without having to reorganize under the protection of bankruptcy, its interest payments are going to eat up a substantial portion of its operating income for a long time to come.
Plus, the financial aid American Airlines received as part of the Coronavirus Aid, Relief, and Economic Security (CARES) Act means no more share buybacks or dividends for shareholders. The company's capital return program was arguably the only reason to even consider owning American Airlines, and now it's gone.
With no guarantees that American Airlines even survives the pandemic without seeking bankruptcy protection, I believe it's fair to say that its stock could still have significant downside.
Image source: Getty Images.
Aurora Cannabis
A 50% decline might also await Canadian licensed marijuana producer Aurora Cannabis (ACB 17.36%). Aurora was actually the most-held stock on Robinhood for months, until a 1-for-12 reverse split in May apparently liquidated the holdings of any members with fewer than 12 shares prior to the split. Nowadays, it's the 11th-most-held company.
I imagine it's probably a bit of a head-scratcher as to why a fast-growing marijuana stock would even make this list. The answer to that question is twofold.
On a macro level, Canada was widely expected to lead the world with its legalization of adult-use weed in October 2018. However, Health Canada delayed the launch of high-margin derivative products by a couple of months. Meanwhile, regulators in select provinces have struggled to review and assign dispensary store licenses. These issues mean that Aurora Cannabis has had to deal with supply shortages in some provinces and major bottlenecks in others.
On a company-specific basis, Aurora has partially come to terms with its problems. A revamped management team has slashed costs and reworked its debt covenant to the point that the company may not default later this year. To avoid default, Aurora must produce positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by fiscal Q1 2021.
However, Aurora Cannabis' cash position is still a concern, and the company has had few avenues with which to raise capital beyond selling common stock. Aurora has been a serial diluter of its shareholders over the past four years.
What's more, the company is lugging around $2.42 billion Canadian in goodwill. Aurora grossly overpaid for most of its acquisitions and will likely be required to take multiple writedowns in the foreseeable future. These impairment charges could be the catalyst that pulls the rug out from beneath the company's shareholders.
