It's a question that most investors start asking themselves almost as soon as they decide to begin putting money in the market: Should I seek safety in broad diversification, or take higher-risk, higher-reward shots with individual stock picks?
The answer is (unsurprisingly), "It depends."
And to some degree, what it depends on are the options you're considering. For example, how much a balance of safety and growth does a given index fund offer? And which individual stocks might be worth their particular risks right now?
One stock that has more than a few investors curious lately is DraftKings (DKNG 2.79%). Although its stock price soared by 10% in the latter part of this past week, it's still down by more than 60% from its September peak, despite the fantasy sports and sports betting outfit reporting year-over-year revenue growth of 47% during the fourth quarter. The company also upped its revenue guidance for 2022, and for the first time ever, is now offering EBITDA guidance (even if that 2021 guidance is less than thrilling).
Image source: Getty Images.
Does this scenario make DraftKings a buy, or would most investors still be better off by simply buying into the entire Nasdaq Composite (^IXIC -0.12%) via a mutual fund, or something similarly broad-based like the Invesco QQQ Trust (QQQ 0.01%) exchange-traded fund?
Again, it depends.
On balance though, a purchase of DraftKings appears to have the edge right now... at least for the right kind of investor.
Bet on the growth of sports betting with DraftKings
Don't misunderstand. If you're a fan of indexing, there's nothing wrong with continuing to buy index funds. And, if you're more of an individual stock person, the usual risks of stock ownership still apply here. Chief among those risks are adverse responses to unexpected headlines, and competitive forces.
Investing is largely about managing risks and rewards, though, and right now, DraftKings arguably offers more risk-adjusted, long-term reward potential than the Nasdaq Composite itself does.
Sure, DraftKings tumbled rather sharply a week ago following the release of its fourth-quarter numbers. While revenue rolled in better than expected, its loss was also greater than the analyst community was anticipating. Several analysts lowered their price targets for the stock afterward, pointing to the fact that the company will likely remain in the red for quite some time. Investors balked.
The thing is, investing in DraftKings isn't really about its profitability... at least, not yet. It's about the premise and the eventual prospect of turning a profit -- which, by the way, management forecasts will happen on an EBITDA basis by 2023. In the meantime, the market may well reward progress toward that goal, which DraftKings is expected to make.
Data source: Thomson Reuters. Chart by author.
The marketplace itself is certainly growing well enough to carry DraftKings out of the red and into the black by then. Market research outfit Technavio suggests the global sports gambling market will grow at an annualized pace of around 10% through 2025, ending that period more than $100 billion bigger than it is now. In a similar vein, over half of the states in the U.S. have legalized sports betting in one way or another. Many of the remainder are considering legislation that would do so, and others have already passed sports betting laws that have yet to be fully implemented. Notably, California is among the states that could pull the legalization trigger next. That's a huge market in itself.
When opportunity knocks
This isn't necessarily the norm, by the way.
More often than not a broad-based investment in the market makes the most sense for most investors. That's particularly true if you're just starting to lay a foundation for a long-term portfolio; index funds make for a great first investment. They inherently bring sector diversification to your holdings, as well as sheer safety in numbers. And, if you're looking specifically for above-average growth, the Nasdaq Composite and the Nasdaq 100 consist of some of the market's best tech innovators. Analysts' collective consensus for the index's earnings growth this year also still stands at more than 30%.That's nothing to scoff at. Had you been comparing these two investment choices a year ago or do so a year from now, the index may well be the better option.
In the shadow of the stock's 60% setback though, the market just doesn't seem to fully appreciate how strong the long-term sports betting tailwind could be.
Bottom line? It's rare to see such secular and cyclical tailwinds for a young industry converge as they are for this particular business right now. It's rarer still to see a key player in these new industries suffer such a setback while those tailwinds are starting to blow in earnest. Once that window of opportunity opens, you have to be willing to enter it before it closes again. That's because these windows don't open very often, and they don't stay open very long.
Of course, DraftKings still isn't an ideal pick for everyone. If you're not willing to keep tabs on the long-term evolution of sports betting and/or can't stomach wild volatility during the years it could take DraftKings to reach profitability, you're still better served by sticking with the Nasdaq's easy-to-own diversity.
