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3 Bad Growth Stories to Avoid at All Costs

By Zhiyuan Sun - Mar 31, 2021 at 6:12AM

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Nobody likes overvalued stocks with diminishing business potential.

Over the long term, companies with bad business models can end up costing investors their entire principal. Nonetheless, they could stick around for a long time by either overpromising on growth dreams or selling turnaround stories to new investors for more capital. 

Successful investing isn't just about picking companies with outstanding growth stories, but also about saying no to those with bad ones, no matter how convincing they first appear. Today, let's look at why shares of a healthcare software company, a brick-and-mortar video game retailer, and a for-profit prison are the top stocks to stay away from. 

Woman stressed out while reading stock price movements.

Image source: Getty Images.

1. Clover Health Investments

Clover Health Investments (CLOV 3.64%) is a healthcare tech company that uses its signature software to enhance physician-patient interactions in the Medicare program. Last year, its revenue grew by 45.6% annually to $672.9 million, while its net loss narrowed by $272.1 million to $91.6 million over the same period. There are more hidden perils here than meet the eye, however.

Clover generated its sales in part from 66,000 of its Medicare members, the vast majority of whom are located in New Jersey. Hospitals in the Garden State happen to have some of the highest billing rates in the nation. While the company claims that its software helps physicians make better diagnoses, doctors who used the Clover Assistant complained that it was basic and burdensome and did not add value for patients. Some even claimed that it "recaptures old, often irrelevant diagnoses that are difficult to remove."

Moreover, the company's business model actually involves paying doctors $200 each time they use the software, then billing Medicare for the subsequent procedural and prescription drug expenses based on the diagnosis. Last year, it paid out 88% of its revenue in medical claims alone. Given its operations in a highly inflated market, questionable software quality, and exorbitant revenue costs, this is one healthcare stock that investors should avoid.

2. GameStop 

Shares of video game retailer GameStop (GME -0.63%) have lost nearly 43% of their value after hitting an all-time high of $483 apiece in January. At one point, its stock was sufficiently undervalued to attract a legendary short squeeze from Reddit traders in the r/WallStreetBets subreddit. 

Now that the hype has cooled off, however, it is essential to note that GameStop stock is arguably the most expensive in the brick-and-mortar space, trading at 1.9 times sales (whereas the average retailer trades between 0.2 to 1.0 times sales). In addition, the company just doesn't have the financials to back up all this speculation.

In Q4 2020, GameStop's sales declined by 3.4%, to $2.12 billion, compared to Q4 2019. Even though the company's same-store sales went up by 6.5% year over year, its overall revenue fell, as GameStop closed down 12% of its unprofitable stores. Last year, it closed down as many as 693 stores out of a total store count of 5,500. For all of 2020, its revenue declined by 21% to $5.09 billion.

Investors may point to the remarkable 191% year-over-year growth in its e-commerce segment as justification to buy the stock now. That reasoning, however, has its own issues. Back in Q4 2020, the company's gross margin actually fell 6.10 percentage points to 21.1%. This was in part due to higher freight fees in its new online sales.

At the end of the day, GameStop is still unprofitable at a net loss of $215.3 million, which is not good news for its $635 million cash balance. Considering the company is still winding-down its base of unprofitable stores, I'd expect its liquidity to shrink further in the coming years. Unless the company can turn around its declining sales, I'd avoid it. 

3. The Geo Group 

Most of the time, when investors develop an interest in real estate investment trusts (REITs), they do so because of the industry's ability to generate consistent and stable cash flows in the form of dividend payments. REIT The Geo Group (GEO -0.32%) simply does not make the cut. 

Geo runs a large chain of for-profit prisons, rehabilitation facilities, and immigration detention centers across the nation. Due to such operators' notoriety during the COVID-19 pandemic, the Biden administration has decided not to renew their government service contracts. Within a few years, Geo will lose a staggering 25% of its overall revenue from the expiration of its U.S. Marshals Service and Federal Bureau of Prisons segments.

Last year, the company's revenue and net income declined to $2.35 billion and $113 million, respectively, from $2.48 billion and $166.6 million in 2019. It is currently generating less in terms of cash flow than it can pay out in dividends.

If that isn't bad enough, the company also faces nearly $3 billion in total debt liabilities amid declining sales and profits. In fact, about 57% of its shrinking operating income is eaten up by interest charges. Overall, this is probably the least favorable REIT stock to invest in right now. 

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Stocks Mentioned

The GEO Group, Inc. Stock Quote
The GEO Group, Inc.
$6.28 (-0.32%) $0.02
GameStop Corp. Stock Quote
GameStop Corp.
$97.77 (-0.63%) $0.62
Clover Health Investments, Corp. Stock Quote
Clover Health Investments, Corp.
$2.71 (3.64%) $0.10

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