Halloween, America's favorite spooky holiday, is this upcoming week. While nearly everyone enjoys a little bit of fun with the holiday, there's a lot less fun involved with the scary roller coaster-like performance the market has offered up to investors recently. When stocks are down like they are right now, it can certainly translate to real-world fright for those who are holding on to them in the hopes of a better long term future.
With that in mind, three Motley Fool contributors volunteered to share the scariest stock currently in their portfolios. They picked Walt Disney (DIS -0.04%), Lemonade (LMND 1.64%), and Ready Capital (RC 1.72%). Read on to find out why, and then decide for yourself whether they represent companies that are too scary to hold, or whether your bigger fear should be the fear of missing out on their potential future returns.
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Eric Volkman (Walt Disney): Walt Disney has produced some of the most comforting and uplifting entertainment in our lifetimes. That's why it's concerning that it's kind of a spooky stock to own these days.
This month, the Mouse's shares fell to levels not seen in almost a decade, because of a number of factors.
A big one is that media and entertainment -- the larger of the company's two core segments -- has seen stagnant revenue growth lately and a fall in operating margin. Another is the once reliable semi-annual dividend, suspended in 2020, which is yet to reappear.
For me, though, it feels as if Disney is at the bottom and looking up. The profitability lag in media and entertainment is due in no small part to the struggles of streaming service Disney+; streaming is a tough business to make coin from, and as it's still new companies are figuring out ways to move it consistently into the black.
Management is well aware of this issue, and those expense-trimming remedies already seem to be having an effect. The direct-to-consumer unit Disney+ has nearly halved its operating loss on a year-over-year basis in the company's third quarter, from $1.06 billion to a far less painful $512 million.
Meanwhile, the company still holds some of the most valuable intellectual property in human history. Star Wars can continue to be lucratively monetized in many ways, including film, TV, consumer products, and theme park attractions. Superhero repository Marvel is a wide and deep gold mine that continues to add value in much the same way.
Management has proved it can at least start an effective cost-cutting program. On top of that, it has numerous less-prized assets it can sell off to help boost the finances, like its low-margin streaming service in India, Disney+ Hotstar, which apparently has a suitor.
Don't ever count out Hollywood's powerful Mouse. This one has roared before, and I have zero doubt it will again.
Scary-good potential; scary-bad execution
Jason Hall (Lemonade): One of the hardest parts of investing is picking the companies with great potential that then actually deliver on that potential. This especially true for companies that are trying to disrupt a large, entrenched market, where the upside is obvious, but a lot of things have to go right for it to work out. AI-powered insurance company Lemonade fits the bill here perfectly.
On the scary-good side, we have the massive market. According to consulting giant McKinsey, the property and casualty segment alone was worth $1.6 billion in 2020, and has been one of the least-disrupted industries. This is at the heart of the Lemonade thesis, which aims to do two things:
- Use AI to speed up and improve the end-to-end insurance process and experience.
- Decouple the existing financial incentives that disalign insurance companies and their clients.
The second innovation seems to be working well, based on Lemonade's growth and retention rates. Customers increased 21% last quarter, while the premium per customer was up 24% as more customers added more kinds of insurance. In-force premiums rose 50% as a result.
The first innovation seems to be working well, except for where it's decidedly not: profitable insurance premiums. Lemonade touts its ability to quickly process and pay claims, and to make underwriting decisions in mere moments in most cases. The problem is it has consistently come up short on its loss ratios, meaning that its AI -- along with its human-assisted underwriting -- has not been good at writing profitable premiums. No business can last for long when it sells its product for more than it costs to produce it. As a result, you have a fast-growing business, that's seen its stock price plummet. A scary combination for investors. Scariest of all could be selling at a loss, only to see the company finally figure it all out.
This stock ended up in my portfolio without me ever buying it
Chuck Saletta (Ready Capital): Earlier this year, I was actively singing the praises of hard money lender Broadmark Realty Capital, going so far as to call it "my top value stock to buy right now." For a business that was technically classified as a mortgage REIT, it had a remarkably healthy balance sheet and a lending profile that gave it a great chance of getting paid even if its borrowers defaulted.
Unfortunately for me, someone with far deeper pockets also recognized the value in Broadmark Realty Capital and acquired it in an all-stock deal. That someone is Ready Capital (RC 1.72%), another non-bank real estate lender, albeit one with a much more heavily leveraged balance sheet than Broadmark had. That all-stock acquisition is how I ended up owning shares of Ready Capital without ever having bought a single share of its stock.
It's that deeper leverage that worries me about Ready Capital. In contrast to Broadmark Realty Capital's nearly debt-free balance sheet before it was acquired, Ready Capital has around $9.5 billion in debt and a debt-to-equity ratio of around three-and-a-half to one.
When you're in the business of lending money, the more money you owe, the more dependent you are on timely and complete payments by your borrowers to keep your own debt adequately serviced. In a high interest rate environment, it can get extra challenging as your borrowers find it harder and more expensive to pay those higher rates.
Indeed, Ready Capital seems to be getting affected by such challenges, as its most recent dividend of $0.36 per share was below the $0.42 it had paid in each of the last two years for the same quarter. As a REIT, Ready Capital must pay out at least 90% of what it earns in the form of its dividend, but if the earnings aren't there to support it, it isn't obligated to pay any more than that 90% level.
Add together a heavy debt load and a shrinking dividend in a high interest rate environment, and it paints a fairly clear picture as to why Ready Capital currently claims the title of the scariest stock I own.
The future is never known until it unfolds
Not every investment will work out, and sometimes, it takes longer than any of us would like for a company to deliver against its ultimate potential. Yet despite that risk and uncertainty, these three Motley Fool contributors buy stocks because a successful investment strategy can be the foundation of a great wealth building plan. That holds true even when an individual company fails to pull its weight in an overall well-designed portfolio.
Only time will tell whether these three currently scary investments will work out for them. Even if they don't, what matters most is having a robust and resilient enough plan to overcome the challenges the market throws our way. Make today the day you start looking at each of your investment in terms of where it really fits within your overall portfolio, and you, too, can join the ranks of those able to stay invested overall, even when faced with some scary individual picks.
