Proceed With Caution When Considering These 5 Ultrapopular Stocks

In her popular book The Scout Mindset, Julia Galef offers an insightful test for whether we are processing new information with an open mind. For statements that don't support your belief, are you asking yourself, “Do I have to believe this?” or are you asking yourself, “Is this true?” It's as applicable to stocks as anything else.

Many shareholders of Tesla (TSLA), AMC Entertainment (AMC), GameStop (GME), Airbnb (ABNB) and Upstart (UPST) cling to the stories of how things can go right. But there is plenty that can go wrong. Caution is warranted for these popular stocks. Here's why.

1. Tesla

Make no mistake. Elon Musk has proved the doubters wrong. Tesla has grown production 74% annually since 2017 and 83% in 2021 alone. Operating cash flow nearly doubled in 2021, and the company appears able to fund itself after diluting shareholders by 28% over the past five years. After years of skepticism, Tesla now rivals BMW for the highest operating margin in the industry.   

Given that it brought in almost $54 billion in revenue in 2021, you might be surprised to learn that the EV maker still isn't even in the top 15 producers of automobiles globally. It sold about one-tenth what Toyota did. Shareholders are banking on it climbing that list. 

Even if it can reach the total volume produced by Toyota with its current mix of vehicles, maintain the profit margins of BMW and garner the valuation of Apple by the end of the decade, shareholders might not realize much return. Meeting those criteria would push Tesla's market capitalization to just above $1.5 trillion — or roughly $1500 per share without further dilution. It's a lot. But it would represent a return of only 4% per year. The company has proven itself. But a lot of future success is priced into the shares. Buyer beware.

2. AMC Entertainment

AMC shareholders probably thought they already had all the bad news about the company memorized. Movie attendance is still roughly half of what it was before the pandemic. Shares outstanding have quintupled. It's still burning cash and has almost $11 billion in debt. Despite all of that, shares are up 1,000% since the beginning of 2021.  

If that doesn't scare you, what about CEO Adam Aron — who netted $21 million in 2020 compensation — buying a minority stake in a gold miner that appeared to be going out of business? Now the tiny mining company won't have to make good on its debt until 2027. It might turn out to be a stroke of genius. But there is a reason Wall Street usually doesn't like surprises. If I'm going to invest in a company, I'd prefer to know what business it is in. Anyone putting their money at risk with the company should be honest with themselves about what they think the future holds and how likely it is to happen. It may turn out to be a great investment. But that would mean beating the odds.

3. GameStop

Similar to AMC's, shares of GameStop are up 77% since the beginning of 2021. Revenue in the latest quarter topped the same period of 2019. That's a great sign that the business is headed in the right direction. It has dramatically reduced its debt, but the company was still burning cash in the latest quarter. That raises the prospect of repeating the dilution of shareholders that occurred in 2021. It may also need the money to continue its push toward non-fungible tokens and blockchain gaming as well as opening new offices in tech-friendly cities.

It's intriguing. This is the kind of turnaround that has a chance at being one books are written about. But the price-to-sales (PS) ratio is 25 times higher today than it was before the pandemic. And board chairman Ryan Cohen — who continues playing the part of populist leader to his meme stock fans — seems to be as interested in his public profile as the company's. Some might ask, “Why not?” It's worked for Elon Musk. But for my investment dollars, the risk/reward ratio is still not tempting.

4. Airbnb

In the company's early days, it offered travelers a cheap alternative to expensive hotels — especially when rooms were hard to find. What started as a way for normal people to make extra money by renting out space in their homes has turned into a $110 billion business. 

Although it looks similar, that business has changed over the years. Pushback from cities led the collection of more taxes, and the professionalization of the short-term rental — and associated fees — has cut into the price advantage. It still offers the ability for short-term renters to find a place to stay at many different price points. The flexibility has been highlighted during the pandemic. In the latest quarter, more than one in five bookings were for 28 days or more. Business is good. 

But several recent news stories have the potential to make people think twice before logging on to the platform for their next trip. In one, a man in Texas was charged with recording people staying at his Airbnb. Police found more than 2,000 pictures of guests at their most intimate moments. In another, a couple discovered they had been recorded and sued the company. The dispute had to go to an arbitrator per the rental agreement's terms of service — a win for the company.

Issues with undisclosed cameras in rented properties have been known for years. And the company has taken steps to try to crack down. But many say the company has done more to protect itself than to protect its customers. As stories like the recent ones become mainstream, it could irreparably harm the brand. At a minimum, it could tempt many would-be customers to give traditional hotels another try. And at this stage of its life, anything that cuts into Airbnb's growth would crush the stock price.

5. Upstart

Credit scores have long been an opaque assessment with a major impact on people's lives. CEO Dave Girouard and team set out to build an alternative using machine learning and by all accounts have succeeded. The Consumer Financial Protection Bureau studied its loans and found that Upstart was able to approve more loans than traditional lending models at a lower interest rate. That opens up lending to millions who didn't have access before. 

It's been popular with its banking partners. Revenue for 2021 climbed 264% over the previous year. And the company earned a profit for each of the last two years. Its ability to team up with lending institutions — rather than being a lender — has been a key to its success. But that doesn't mean it isn't exposed to credit risk. 

Many of the loans made by its bank partners are lumped together for sale to investors — or securitized. It's a financial flywheel that requires the loans to generate enough profit for the lenders, Upstart, as well as investors purchasing the loans in the capital market. The Great Financial Crisis showed that even if the securitization process spins freely, the fear of defaults could cause the gears to grind. I think Upstart has a better chance than not of succeeding. But it's a risk those holding the shares should be careful to weigh.

Should you invest $1,000 in Upstart right now?

Before you consider Upstart, you'll want to hear this.

Our award-winning analyst team just revealed what they believe are the 5 top under-the-radar stocks for investors to buy right now… and Upstart wasn't one of them.


Originally published on Fool.com

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Jason Hawthorne owns Upstart Holdings, Inc. The Motley Fool owns and recommends Airbnb, Inc., Tesla, and Upstart Holdings, Inc. The Motley Fool recommends BMW. The Motley Fool has a disclosure policy.

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