We're only a quarter of the way through 2021, but things are looking up for equities. The iconic Dow Jones Industrial Average ended Q1 higher by nearly 8%, with the benchmark S&P 500 tacking on close to 6%. Considering that the stock market has gained approximately 7% annually, inclusive of dividend reinvestment, throughout history, we look to be on pace for another above-average year of returns.
But as any tenured investor will tell people, an uptrending market doesn't mean all stocks will be winners.
For example, the following five stocks have been exceptionally popular within the investment community, yet all have significant flaws that simply can't be overlooked at their current valuations. These are the companies investors should be actively avoiding like the plague in April.
Since late January, movie theater chain AMC Entertainment (AMC -0.15%) has been a primary target of retail investors on Reddit's WallStreetBets chatroom. These predominantly young and novice investors have been focusing on companies with high levels of short interest and attempting to effect a short squeeze. They were successful in doing so two months ago and sent AMC to as high as $20 per share.
But peel back the fanaticism surrounding the Reddit trade, and you'll see that there's actually less substance with AMC than with most other Reddit stocks.
For instance, AMC has a large net debt position and more than $1 billion in cash, according to the company's fourth-quarter operating results. While significantly increasing its share count and issuing more than $400 million in debt capital helped the company stave off bankruptcy in January, it's left AMC with few options moving forward. If shareholders decline to allow the company to sell up to 500 million shares, AMC may not have enough cash to make it through 2022. Meanwhile, if they approve the measure, AMC will likely survive, but shareholders will be drowned by dilution. It's a no-win scenario.
From an operating standpoint, AMC is a long way from even getting back to where it was in 2019. It's facing streaming competition for new film releases from AT&T's WarnerMedia and Walt Disney, and the company is operating at much less than 100% capacity in its theaters. According to Wall Street's consensus, AMC won't be making money until 2024, at the earliest.
With the prospect of a short squeeze not looking so hot, AMC Entertainment should be the No. 1 stock to avoid in April.
A somewhat common theme you'll note on this list are companies that have been targets of the Reddit community. While not all so-called "Reddit stocks" are bad news, quite a few stand out for their insane valuations that can't be justified. Clinical-stage veterinary drug and diagnostics developer Zomedica (ZOM -5.59%) is a good example.
Zomedica initially received a boost in January after Tiger King star Carole Baskin was paid to namedrop the company in a YouTube video. A few weeks later, it caught the attention of retail investors, who seem to love penny stocks almost as much as short squeeze opportunities. However, neither of these catalysts offer anything tangible for investors to get excited about.
If there is a marginal positive, it's that Zomedica sold its first-ever Truforma diagnostic system in March, so it's now a revenue-generating company. It also sold quite a bit of stock to raise capital and ease its cash-burn concerns. Nevertheless, Zomedica is valued at roughly 70 times Wall Street's forecasted sales for three years from now, and it's not expected to be profitable anytime soon.
Further, the only way Zomedica was able to ease its cash concerns was by burying its investors in dilution. Since the year began, Zomedica's share count has jumped by more than 305 million. It's not a stock that should be in long-term investors' portfolios.
Keeping with the theme of Reddit stocks whose valuations don't make one shred of sense, we have video game and accessories retailer GameStop (GME 0.92%). GameStop was the very first company to gain notoriety for its short squeeze in mid-January. At the time, GameStop's short interest was over 100%.
However, the dynamics of GameStop's short squeeze in January are very different from what we see today. Short interest in the company has declined dramatically, and the company's high daily trading volume would make it easy for short-sellers to exit the stock, should they choose to do so. Without the feeling of being trapped in their positions, any squeeze event in GameStop is going to be very short-lived.
Beyond the primary buy thesis in GameStop being broken (i.e., holding for a short squeeze), the company's operating performance is still mediocre, at best. Though e-commerce sales rose 191% in 2020, the company's total sales declined by 21%, partially because of the closure of 12% of its stores. Even with GameStop laser-focused on promoting digital gaming, its sales will be relatively flat for years and it'll be closing stores in an attempt to backpedal its way into the profit column.
In other words, we're talking about a company whose shares were up 900% in the first quarter that's essentially running in place. GameStop isn't where you want to put your money to work in this market.
In early February, Cassava released positive clinical data from an interim analysis involving lead drug candidate simufilam as a treatment for Alzheimer's disease. The open-label study demonstrated improvements in cognition and behavior scores at the six-month mark, with no safety issues noted. With this data release coinciding with the Reddit frenzy, Cassava Sciences stock was sent into the stratosphere.
On a bright note, the company ended February with approximately $280 million in cash after netting almost $190 million in a registered direct share offering. This should give Cassava more than enough capital to fund its research for years to come.
On the other hand, the late-stage outcome for Alzheimer's disease therapies is incredibly poor. Over the past decade, multiple mid-stage treatments have shown promise, only to fall flat in larger blinded studies. In particular, the failure rate for Alzheimer's treatments has been especially high among lesser-known drug developers.
While I'd love to see Cassava succeed, given how terrible Alzheimer's disease is, history suggests it's a longshot to do so. Investors would be wise to invest their money elsewhere in April (and beyond).
American Airlines Group
Lastly, investors would be smart to keep their distance from American Airlines Group (AAL 3.55%) in April.
American Airlines, and airline stocks in general, have been popular companies to buy as part of the U.S. reopening trade. With the U.S. making significant headway on the coronavirus vaccination campaign, the hope is that travel numbers will pick up later this year and perhaps even return to pre-pandemic levels by 2022. This, of course, assumes that enough people choose to get vaccinated, and that variants of the disease don't minimize their effectiveness of existing vaccines.
Even if things go perfectly for the airline industry, it could still be a struggle for American Airlines to survive, let alone thrive. We're talking about a company that's lugging around $41 billion in total debt and over $34 billion in net debt. Between its decision in 2018 to modernize its fleet before it was necessary and the pandemic, American Airlines will likely be constrained by its debt throughout the decade.
What's more, the airline industry requires hefty capital inputs to generate mediocre margins during even the best of times. With bare bones regional airlines willing to undercut majors like American Airlines on price, the future doesn't look promising.