Following the crowd isn't always a good idea -- and that's as true in the investing world as it is anywhere else. Sometimes, a stock that's popular at one moment can turn out to be a dud business later. Investors who want to generate above-average returns over the long run shouldn't initiate a position in a stock simply because it is getting a lot of buzz.
For example, consider Aurora Cannabis (ACB -2.86%) and Uber Technologies (UBER -3.65%) -- two stocks that are certainly popular in some circles right now. Both have regularly shown up on the list of the 100 most widely held stocks in the portfolios of those using Robinhood Markets' trading platform. But fundamentally, they aren't worth investing in.
The case against Aurora Cannabis
Marijuana grower Aurora Cannabis has been plagued with problems for years, some of its own making and others caused by factors outside its control. Let's start with one issue in the latter category.
Aurora and its peers in the Canadian market thought they had struck gold when cannabis was finally legalized there in late 2018. However, regulatory authorities complicated things. For instance, the province of Ontario -- that country's largest by population -- implemented a complex lottery system for businesses to obtain cannabis retail licenses. This had a severe impact on companies in the space.
As Mark Zekulin, former CEO of Canopy Growth said back in November 2019: "The market opportunity today is simply not living up to expectations and, at the risk of oversimplifying, the inability of the Ontario government to license retail stores right off the bat has resulted in half of the expected market in Canada simply not existing."
While things have gotten better in the nearly two years since Zekulin uttered these words, this issue meaningfully contributed to the headwinds Aurora Cannabis has encountered.
Second, Aurora Cannabis was unable to attract a big-name partner with deep pockets. This matters a great deal. Marijuana companies have had trouble accessing most of the usual sources of business funding due to the nature of their business activities. That's why some partnered up with established corporations in adjacent markets. For instance, tobacco giant Altria owns a 42% stake in Cronos Group, while alcoholic beverage company Constellation Brands owns 38.6% of Canopy Growth.
Aurora Cannabis appointed billionaire investor Nelson Peltz as a strategic advisor in March 2019 to help it "explore potential partnerships that would be the optimal strategic fit for successful entry into each of Aurora's contemplated market segments." But Peltz resigned from that role in September 2020, and Aurora still lacks a partner. Of course, the company could be successful without one. But it is worth noting that a collaborator could be highly beneficial to it, and when it tried to find one, it failed.
Third, early on, Aurora Cannabis adopted an aggressive strategy that relied on making acquisition after acquisition. Since the company did not have the cash to fund its spending spree, it had to pay for those acquisitions in common stock. This significantly contributed to Aurora Cannabis' persistent share dilution problems.
Amid all these issues, it has constantly disappointed shareholders with its subpar financial performances. And while the company is working to turn things around (it is aggressively looking to reduce expenses and costs, for instance), these efforts have yet to bear fruit consistently.
It's hard to make a strong case for this cannabis stock right now. Investors should stay away.
The case against Uber Technologies
Uber pioneered the ride-sharing business model, and it seemed like a genius concept at first. But its drawbacks soon became apparent. Uber is often accused of underpaying its drivers, most of whom aren't classified as employees in the U.S. Classifying its drivers as such would lead to a significant increase in the company's expenses since employees are entitled to minimum wage, paid vacations, and sick leave, among other things, while independent contractors are not.
Uber is currently engaged in an intense battle in California over legislation that would force the company to classify its drivers there as employees. And late last year, Seattle enacted a law that stipulated that Uber's drivers would be entitled to a minimum wage starting in January 2021. Other states could follow suit, and regulators abroad have taken notice. Uber lost a lawsuit in the U.K. and, as a result, had to classify more than 70,000 drivers in the country as employees.
This cloud will hover above the company's head -- possibly for many, many years to come -- and put downward pressure on its share price. Corporate image matters, and as long as Uber has a reputation for not treating its drivers well, that's another risk for the company. On the other hand, it can't afford a significant increase in its operating expenses either unless it boosts its prices. Uber is not currently consistently profitable. Management says they expect to achieve quarterly adjusted EBITDA profitability this year, but that is not the same as a net profit.
The pandemic added to Uber's challenges. Lockdowns and social distancing efforts drastically reduced demand for rides -- and thus for drivers. Even as things have been getting back to normal, many of the drivers who left the platform last year have not been eager to return. In April, Uber launched a $250 million pay-boosting initiative to attract drivers and couriers for its food-delivery business. The company says it has made progress along these lines thanks to this and other incentive programs.
But again, the company failed to achieve consistent profitability even when it was paying less. They also may be forced to spend more on benefits, unemployment insurance, and ensuring that its drivers at least earn minimum wage for their work.
Uber's driver shortage may prove to be a temporary headwind, but the legal and regulatory challenges it faces are unlikely to be transitory. The company's business model rests on its ability to claim that its drivers are not its employees. As long as the risk persists that it may lose that ability, I'd recommend staying away from Uber's stock.