While it's important to choose strong companies to grow your nest egg over the long haul, allocating a small percentage of your portfolio to high-risk, high-reward stocks can be worth it.
Stocks that are deemed high risk by Wall Street will usually fall the furthest during a bear market. But if you sift through the noise and focus on the business qualities that could allow a beaten-down stock to survive turbulent times, you could be in for a real winner when the dust settles. What follows are three promising stocks selected by a team of Fool.com contributors that could deliver similar returns on the other side of the market madness.
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There's light at the end of the tunnel for Alibaba
John Ballard (Alibaba): The leading e-commerce platform in China has been through the gauntlet over the last 12 months. Over the last year, shares of Alibaba Group Holding (BABA 0.09%) are down 53% following the Chinese government's recent scrutiny over large internet platforms. If that wasn't enough of a headwind, the U.S. Securities and Exchange Commission (SEC) has threatened to delist Chinese stocks that don't comply with auditing rules.
Alibaba is a dominant technology provider in China. On top of its 1 billion active customers who shop across its e-commerce marketplaces Taobao and Tmall, it is also the top cloud service provider in China and operates several other businesses in logistics and digital.
The regulatory concerns have sent the shares down to a valuation of 13.6 times this year's earnings estimates. Alibaba was trading at over 30 times earnings a year ago, so there is substantial upside once the uncertainties subside, and that appears to already be happening.
Analysts at J.P. Morgan recently upgraded Chinese tech stocks, including Alibaba, after previously telling investors to avoid them a few months ago. It's becoming more apparent that the risk of being delisted from U.S. exchanges is probably overblown. Recently, New York Stock Exchange Vice Chairman John Tuttle told Barron's that the number of Chinese companies listed in the U.S. will remain the same, if not grow.
Alibaba reported year-over-year revenue growth of 9% in the most recent quarter. Economic headwinds in China have weighed on top-line growth recently, but at a price-to-earnings multiple of less than 15, the market is significantly undervaluing Alibaba's leadership position in e-commerce, in addition to continued growth from the cloud and other moonshot opportunities over time.
Beaten down but still expensive
Jennifer Saibil (MercadoLibre): Tech stocks continue to get beaten down in the current market, but not all tech stocks are created equal. So while many of them were trading at astronomical valuations without much justification, the ones that still deserve some premium are getting knocked down just the same. That creates an excellent buying opportunity, and MercadoLibre (MELI -1.98%) is one stock whose price has plunged despite exceptional performance.
MercadoLibre is a leading Latin American e-commerce company that is also developing fintech capabilities. Pandemic growth was explosive, with four consecutive quarters of triple-digit sales growth. That's come to an end, but growth is still seriously strong. In the first quarter, sales increased 67% year over year to $2.2 billion. Total payment volume was up 82%, and gross merchandise volume (GMV) was up 31%. GMV increased at the same rate as the 2021 fourth quarter despite facing tougher comps. That was on top of last year's stellar performance, so although there was deceleration, I would call that anything but slowing down.
The most improvement was seen in the core markets of Argentina, where the company is headquartered, and Brazil. Buyer frequency and unique buyers increased over last year even as shoppers resumed normal shopping habits. MercadoLibre is a leader in all 18 Latin American countries where it operates, and the opportunity to grow in its smaller markets is immense. One under-the-radar opportunity is ad revenue, which almost doubled over last year. Management has been investing in the advertising platform, and while that's adding to near-term pressure, it's already paying off, and should continue into the future as it builds out.
That's just one example, but there are so many ways the company is scaling, including digital payment options, improvements in delivery, better search functions, and improved technology.
MercadoLibre's stock price soared to a sky-high valuation last year, and some correction isn't surprising despite the opportunities. Even at this price, down 40% this year, shares trade at 220 trailing-12-month earnings. That creates risk, especially in the current market climate. But the long-term reward potential looks very compelling.
Investors are getting good odds with DraftKings
Parkev Tatevosian (DraftKings): Risk and return are two sides of the same coin. Investors looking for significant returns should understand it typically comes with higher risk, and DraftKings (DKNG -1.35%) is no exception. The mobile gambling company offers online sports betting, iGaming, and daily fantasy sports. The gambling nature of the business is why DraftKings is a risky investment.
It needs state legislatures to legalize the services it offers, and then it needs to gain approval to operate in the jurisdiction. So far, DraftKings is live in 17 states for mobile sports betting, representing 36% of the U.S. population. It has made less progress with iGaming, where it is live in just five states, representing 11% of the population.
The upside is that where it has gained approval, it is proliferating. Revenue has grown from $192 million in 2017 to $1.3 billion in 2021. And its popularity makes sense: Before online gambling, some folks had to drive hours to their nearest casino to get a little wagering action. With mobile gaming, they can start placing bets within seconds.
Another significant risk for DraftKings is that it must spend heavily to get the word out. The company spent $321 million on sales and marketing in its most recent quarter, which ended on March 31. Unfortunately, this trend has gone on for several years with no end in sight. DraftKings has yet to achieve profitability, with no guarantee to investors that it ever will.
DKNG PS Ratio data by YCharts
But the reward is worthwhile if DraftKings succeeds in reaching efficiencies in scale by accessing more customers in new states. The stock is down considerably off its high, making the risk-reward profile more favorable to investors willing to roll the dice on this beaten-down growth stock.
