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2 Unsustainable Growth Stocks to Avoid

By Zhiyuan Sun - Apr 22, 2021 at 6:20AM

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Be wary of companies posting abnormal growth rates.

In a perfect world, companies classified as growth stocks would steadily improve their sales and earnings year after year, making no amount too expensive for their stock price. However, what ends up happening is that such companies often lose their trajectory due to a changing market or a one-time opportunity that quickly dissipates. 

Such forward-looking risks aren't really present in past financial data, so many investors are surprised once a growth stock's sales fall off a cliff. Two such companies that are currently facing this potential future are Coinbase (COIN -9.36%) and Fulgent Genetics (FLGT -0.87%). Let's look at why it's in your best interest to avoid them for the time being.

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1. Coinbase

Coinbase is arguably one of the hottest IPO stocks of the year. As of April 16, the cryptocurrency exchange has attained a market cap of $86.5 billion after accounting for all diluted shares (261.3 million total). Despite growing its revenue by more than 139% year over year, its sales stood at just $1.277 billion last year. Is the stock worth it with its valuation of 57.3 times price-to-sales (P/S) and 268.4 times price-to-earnings (P/E)? 

The problem with Coinbase is that 96% of its revenue currently comes from trading fees. The company first charges a 0.50% spread as remuneration for making a trade, then attaches the greater of a flat fee or 1.49% to 3.99% of the value of the transaction.

Right now, cryptocurrency exchanges are trending toward lower fees, not higher. For example, exchanges like Bittrex and Binance charge as little as 0.1% to 0.25% commission for crypto trades. Coinbase also does not have any access to initial coin offerings (ICOs), and only has a limited number of altcoins available for trading.

So, there is an incentive for active traders on Coinbase to migrate toward better, low-cost brokerages. While Coinbase's revenue, earnings, and trading volume have all exploded higher, its membership count only increased by a moderate 34% year over year to 43 million.

I'd consider waiting quite a bit before going long on the stock. The promising aspect of Coinbase is its separate platform for institutional investors. However, the company is simply too exposed to the risks of retail trading (and its fees) for the moment, not to mention its overvaluation

2. Fulgent Genetics 

Given that they're trading at 3.2 times sales and 7.4 times earnings for a revenue growth rate of 90%, many investors wonder why shares of this genetic testing company aren't a screaming buy. Indeed, Fulgent billed at least 3.2 million tests last year, most of which were for diagnosing COVID-19. Its revenue and earnings per share amounted to $295 million and $6.16, respectively, in Q4 2020 alone. Those are pretty remarkable metrics for a company with a market cap of $2.56 billion.

However, all that growth is coming to an end as coronavirus vaccinations take off in the U.S. By July, all adults who need a vaccine will likely be able to receive one, severely curtailing the need for consumer COVID-19 testing.

This year, Fulgent expects to generate $800 million in testing revenue ($730 million of it from COVID-19 testing), which doesn't seem very plausible. Last year, it made a majority of its profits in the seven months between May and December, when testing volume began to take off. In Q1 2021, COVID-19 testing volume, especially at drive-through locations, was already down from its all-time highs. It's therefore hard to see how the company will be able to maintain its growth from residual testing volumes during the six months from January to July.

The company did land a contract from the Department of Homeland Security (DHS) to supply COVID-19 tests for national security purposes, along with three other labs. Assuming the four share the contract value equally, Fulgent would receive $100 million per year in revenue from DHS for the next five years. Outside of COVID-19 testing, Fulgent deploys gene sequencing tests that can screen for hereditary diseases, cancer, and more. It estimates the segment will grow by 92% year over year to generate $70 million in sales for 2021.

That is nothing, however, considering about $730 million of its COVID-19 testing revenue (if it even achieves that goal) is on the verge of a massive revenue decline, explaining why its stock is trading for so cheap. That's not to say Fulgent is a bad company by any means, but investors should definitely steer clear of its past (and largely one-time) success and look toward what's looming ahead. It's best to wait a few years for its next-generation gene sequencing test sales to catch up before buying the stock.

Zhiyuan Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Fulgent Genetics, Inc. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Coinbase Global, Inc. Stock Quote
Coinbase Global, Inc.
$75.66 (-9.36%) $-7.81
Fulgent Genetics, Inc. Stock Quote
Fulgent Genetics, Inc.
$49.09 (-0.87%) $0.43

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