Regardless of whether you're a new investor or someone who's navigated their way through many market cycles, the stock market always has new tricks up its sleeve.
Last year, we witnessed the quickest bear market decline of at least 30% in history, as well as the most robust bounce-back rally to new highs on record. West Texas Intermediate crude oil futures also plunged into negative territory. It was a history-making year in many respects.
But 2021 hasn't been without its firsts. The Reddit-fueled retail investor frenzy has been responsible for heightened volatility in heavily short-sold companies and dozens of penny stocks. With the idea of "getting back at the big money," retail investors on Reddit's WallStreetBets community chatroom have effectively banded together to buy shares and out-of-the-money call options on heavily short-sold companies and penny stocks. In some instances, they've effected historic gains over a very short time frame.
Unfortunately, history has often proved unkind to emotion-driven monster rallies. At the moment, there are five ultra-popular stocks associated with the Reddit frenzy that could ultimately cost investors most, or perhaps even all, of their money.
Movie theater chain AMC Entertainment (AMC 7.01%) is one of the most-held stocks among young investors. It was an especially popular play in late January, with its combination of high short interest and penny stock status sending its share price into the stratosphere. It's also benefited in recent weeks as a potential coronavirus reopening play.
However, betting on upside in AMC is dangerous for two key reasons. First, it's uncertain if AMC even has enough capital to make it through 2021. Though it was able to raise $917 million in mid-January through a combination of selling nearly 165 million shares and offering debt, this cash is unlikely to last the entire year with some of its theaters still closed and most having reduced capacity.
The second issue for AMC Entertainment is that streaming content providers are gaining the upper-hand on new movie releases. AT&T subsidiary WarnerMedia is debuting its new movies in 2021 on HBO Max the same day they'll hit theaters. Walt Disney is doing something similar with its Disney+ service for a handful of movies. The point is that AMC's operating model is shifting, and not for the better. Bankruptcy remains a possible outcome for AMC Entertainment.
There's no question that marijuana stocks could offer some amazing returns over the coming decade. But in a sea of amazing choices, young investors have latched onto one of the worst of the bunch: Canadian licensed producer Sundial Growers (SNDL 0.71%).
Like AMC, Sundial rallied for its combination of high short interest and penny stock share price. Investors also seem to love the more than $600 million in cash that the company has raised. The problem is that Sundial's cash-raising activities are the result of multiple share offerings, at-the-market share issuances, and debt-to-equity swaps. In my more than two decades of investing, I can only recall one or two instances where I've seen a company issue more than 1 billion shares in five months. With approximately 1.66 billion shares outstanding, Sundial has virtually no chance of ever producing meaningful earnings per share.
Another problem with Sundial is that it's chosen to shift its operating focus at precisely the time when most North American pot stocks are turning the corner to profitability. By altering its focus from wholesale cannabis to retail, Sundial will be tackling a higher-margin component of the cannabis market. But in the meantime, it's facing some ugly year-over-year comparisons and taking a host of writedowns. Between its slow projected sales growth, ongoing losses, and incessant dilution, I wouldn't be shocked if Sundial's stock lost 70%, or more, of its value.
Another ultra-popular stock among millennial and novice investors that could ultimately prove to be a dud Is cryptocurrency mining company Riot Blockchain (RIOT 1.09%). Riot has benefited from the soaring price of Bitcoin (BTC -0.75%) and its previous penny stock share price.
Cryptocurrency miners like Riot use high-powered computers to solve complex mathematical equations that validate groups of transactions (known as a block) on Bitcoin's blockchain. For each block validated, Riot is given a block reward, which currently equates to 6.25 Bitcoin (worth about $350,000). The concern is that the barrier to entry in crypto mining is virtually nonexistent, meaning Riot's competition is growing all the time. It also doesn't help that Bitcoin's block rewards halve every couple of years. That sets the company up for decelerating profits over time.
Even more concerning is the volatility inherent in Bitcoin. Since crypto mining companies are bereft of innovation, they're reliant on a higher price for Bitcoin to generate meaningful profits. However, the world's largest digital currency has declined by 80% on three separate occasions over the last decade. It's not clear that Riot Blockchain could withstand such a move, especially with the crypto mining space growing more crowded by the day.
Koss (KOSS 7.47%), a manufacturer of headphones, Bluetooth speakers, and communication headsets, is another stock that'll make rational investors scratch their heads. It may not be as well-known as AMC Entertainment, but its share price has rocketed form $2 to as high as $174 (in premarket trading) in a matter of weeks, all thanks to the Reddit frenzy.
What's worrisome about Koss is that its business model is based on highly commoditized products. The company operates in a very crowded space, and its supply chain is susceptible to disruption and margin/pricing pressures. It's been unprofitable in three of the past four years (2017, 2018, and 2020), and was only marginally profitable in 2019.
Furthermore, at no point over the past decade, prior to late 2020, had Koss been valued outside of a range of 0.5 to 1.1 times sales. It's currently valued at closer to 12 to 13 times sales in 2021.
As one final note, $506,700 of the $635,819 Koss has logged in net income through the first six months of 2021 is the result of a forgiven Payment Protection Program loan that was recorded as income. Take this out of the equation, and Koss is on track for only a few pennies per share in net income this year. In other words, it wouldn't be a surprise if Koss eventually lost close to 90% of its gains.
Lastly, a list of Reddit rally stocks that could ultimately cost you a fortune isn't complete without video game and accessories retailer GameStop (GME 20.46%). Shares of GameStop have rallied more than 1,300% on a year-to-date basis, but have been on a wilder roller-coaster ride than all other Reddit stocks.
To grasp at straws, GameStop did manage to increase its 2020 holiday season e-commerce sales by 309%, which led to some impressive sequential quarter sales comparisons. However, total sales still declined by 3.1%, with the company's base store count down 11% from the previous year.
The prime issue here is that GameStop has always been a brick-and-mortar gaming retailer. It waited far too long to begin pushing into digital gaming and is now trying to play catch-up. A good comparison to GameStop's late entrance into digital gaming is IBM's tardy entrance to cloud computing. Pull up a 10-year chart of what's happened to IBM, and you'll probably be far less enthused about GameStop's chances of a turnaround.
With the company closing stores in an effort to cut costs (i.e. backpedaling to profitability), yet still on track for another money-losing year in 2021, my suspicion is its shares could decline by 80% to 90% over the next year.