Investing in fast-growing companies can be risky. Often these are businesses that are not yet profitable on the bottom line. Additionally, they are likely to be relatively young companies and competing against established companies with more experience and resources. Or they might be creating new categories and industries, which are yet to have an established group of customers. These are just a few of the risks associated with investing in growth stocks.
The other side of the coin is that investing in growth companies can deliver exceptional stock returns in the long run, which is why folks are willing to take the risk to begin with. If you are such an investor, willing to take on the risk for the potential of great returns, here are three growth stocks that may be right for you.
Growth stock investing is not for everyone. Image source: Getty Images.
1. Peloton
Interactive exercise equipment manufacturer and seller Peloton Interactive (PTON -2.24%) is a hit with consumers. The company's machines allow folks from around the world to exercise together synchronously through instructor-led classes. Remarkably, the company doubled revenue in 2019 and then doubled it again in 2020. The pandemic certainly boosted demand for in-home exercise equipment, but Peloton was on fire even before.
Peloton first came to market with an interactive bike. Recently, it has added a treadmill to the mix. Interestingly, the market for treadmills is much larger than that for bikes. Given how popular the interactive bikes are with consumers, Peloton has a good chance of success with the treadmill.
To help the company with its growth ambitions, it acquired Precor, a manufacturing company based in the U.S. That will allow Peloton to increase supply and also reduce costs through scale. Those will be important factors as Peloton grows by adding new products and expanding to one or two new markets each year.
Still, there are risks to Peloton's growth plans. First, there is the risk of economic reopening worldwide and its dampening effect on demand for in-home exercising. Then there are product safety issues the company is dealing with that led it to recall some of its products earlier this year. Any investor interested in the stock should keep these in mind as part of their evaluation.
2. Skillz
Skillz (SKLZ 0.96%) is a unique gaming platform that allows players to wager real money on mobile games they play against each other. Not all players on its site choose to play the monied option, and it does offer free-to-play games as well. However, the company makes most of its revenue by bringing players together in contests with wagers and taking a fee for the service.
In 2019 and 2020, Skillz grew revenue by 136% and 92%, respectively. The company maintains a competitive advantage on two fronts in the gaming industry. First, giving players the option to bet on games makes them more interesting than free-to-play options. Then, because their contests are skills-based, they are not subject to regulatory constraints.
Management is focused on putting the pedal to the metal to cement its competitive advantage. The company has 2.4 million monthly active users and can grow by adding more. Indeed, Skillz is investing heavily in player acquisition. In its most recent quarter, it spent 117% of revenue on sales and marketing.
There are risks with this strategy. Investing more money on sales and marketing than you earn in revenue is not a sustainable growth path. Eventually, that will cause the company to run out of money. And there is no certainty that revenue will accelerate fast enough to outgrow the spending on user acquisition.
Growth stocks can be riskier than average stocks. Image source: Getty Images.
3. DraftKings
DraftKings (DKNG -0.87%) is a service that offers players daily fantasy sports contests, mobile sports betting, and iGaming. The company first started with daily fantasy sports and, in the last few years, added mobile sports betting and iGaming. For many folks, the nearest land-based casino can be hours away, so having a gaming option in the palm of your hands is a nice alternative.
Importantly, DraftKings is live with mobile sports betting and iGaming in only 12 and four states, respectively. Momentum is increasing for legislation to allow the activities in more states across the U.S. Most recently, regulators in the potentially lucrative gaming market of New York indicated they would allow mobile sports betting. As more localities are being added to the market, DraftKings is capturing players and increasing revenue. In fact, revenue growth has accelerated in the previous three years, going from 17.9% in 2018 to 42.9% and 90% in 2019 and 2020.
That being said, there is no guarantee the company will find success in getting access to more states. The regulatory process can be fickle, and consumer sentiment on gaming can turn in a heartbeat.
Growth stocks can experience big gains and big losses. Image source: Getty Images.
Investor takeaway
Peloton, Skillz, and DraftKings are all adding customers and growing revenue, and have avenues to expand that trend exponentially. However, they are each faced with risks that could stop them in their tracks. The rewards seem to outweigh the risks for potential investors, justifying taking a chance on these growth stocks.
