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2 Hot Stocks to Avoid at All Costs

By Timothy Green - Feb 23, 2021 at 7:30AM

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These money-losing companies won't get a free pass forever.

Investing seems easy when almost everything is going up. It's been hard to lose money in the stock market over the past year as stocks rebounded from the pandemic crash last March. Growth stocks have done particularly well, as investors have been willing to pay ever-increasing prices for growth in a world of ultra-low interest rates and pandemic uncertainty.

Nothing lasts forever in the market, and this won't either. Not every fast-growing company is truly worth dozens of times annual sales, especially if there are no profits to speak of. All it takes to derail a growth stock is a crack in the story.

Shares of ridesharing leader Uber (UBER -3.28%) and social media company Snap (SNAP -5.37%) are trading near their all-time highs after rallying over the past year. Neither company is even close to turning a profit, and any shift in market sentiment could send both stocks tumbling.

Money on fire.

Image source: Getty Images.

Uber

The case for investing in ridesharing giant Uber once centered around a shift to self-driving vehicles, which would lower costs and boost profits. There was never any reason to believe that Uber would have a distinct advantage in self-driving technology, though, or that rival ridesharing services wouldn't enjoy the same lower costs.

Uber has now effectively given up on developing its own self-driving technology, selling its self-driving unit late last year. The new narrative is restaurant delivery. Uber has been growing its Uber Eats service during the pandemic, and the company shelled out $2.6 billion for Postmates to better compete with market leader DoorDash.

This is not good news for Uber investors. It's hard to find a worse business than third-party restaurant delivery. DoorDash has something like a 50% market share in the U.S. during a pandemic that has greatly restricted in-person dining and forced restaurants to pivot to delivery, and the company still can't turn a profit. Uber posted a net loss of nearly $7 billion in 2020.

Scaling a structurally unprofitable business is not going to help Uber's bottom line, but it's the growth story that the market seems to care about. Uber is valued at more than $100 billion, or roughly 9 times its annual revenue. The stock is close to an all-time high despite the original self-driving car narrative going up in smoke.

There's no question that Uber offers useful services, but that doesn't automatically mean that Uber is a good business, and it certainly doesn't mean that Uber is a good stock. Uber seems to be pursuing a "growth at all costs" strategy by going all-in on food delivery. Investors buying into the story are likely to get burned.

Snap

Snapchat is no longer the hot social media app that younger users are flocking to. TikTok holds that crown today, and something else will inevitably take its place down the road.

Snap has managed to keep Snapchat's user base growing despite the rise of TikTok. Daily active users were up 22% year over year in the fourth quarter to 265 million. The pandemic is probably helping the cause as people turn to social media for entertainment and connection.

This massive user base hasn't translated into profits. Snap lost just shy of $1 billion in 2020, even as revenue soared 46%. Snap did report positive adjusted earnings before interest, taxes, depreciation, and amortization for the year, but adjusted EBTIDA is not a good measure of profitability. The metric backs out a bunch of very real costs, including the massive amount of stock-based compensation Snap doles out each year.

Snap could someday become profitable, just as Twitter managed to start producing profits after years of big losses. But Snap is already worth nearly twice as much as Twitter. Snap's market capitalization topped $100 billion recently, or about 40 times annual sales. That valuation rivals those of the hottest cloud software companies, which probably have much better chances of producing meaningful profits in the future.

Growth is what the market cares about right now. Snap is certainly delivering on that front, but its investors need to be careful. The market's obsession with profitless growth won't last forever.

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Stocks Mentioned

Uber Technologies, Inc. Stock Quote
Uber Technologies, Inc.
UBER
$23.59 (-3.28%) $0.80
Snap Inc. Stock Quote
Snap Inc.
SNAP
$23.42 (-5.37%) $-1.33

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