Markets soared on the news of a preliminary de-escalation in the tariff war between the U.S. and China, with the main indices jumping between 2-3%.

This development had investors screaming buy buy buy, which could indicate a renewed willingness to allocate capital to equities. However, caution remains warranted. The markets could turn on a dime, as they have many times this year. A number of fundamentally weak and overvalued companies continue to trade at unjustifiable valuations, posing serious risks to unsuspecting investors.

This week’s Danger Zone pick highlights a company with a large cash burn and a valuation predicated on highly unrealistic expectations. For instance, the stock’s current price implies the business will simultaneously achieve unprecedented profit growth and a sevenfold increase in market share. This stock represents a material risk to any portfolio.

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This stock could fall further based on:

  • persistently high operating costs,
  • large cash burn,
  • lagging market share,
  • more profitable competitors, and
  • a stock valuation that implies the company will grow its market share 7x while also growing profits to levels never seen before.

Adjusted EBITDA Misleads Investors

This company’s management provides a misleading view of the company’s profitability when it directs investors to its “Adjusted” EBITDA. From 2019 to the TTM, the company’s Adjusted EBITDA improved from $29 million to $167 million, while its GAAP net income rose from -$1 million to $16 million.

Over the same time, the company’s economic earnings, the true cash flows of the business, fell from -$11 million to -$88 million. It is a big red flag when the company’s preferred non-GAAP metric is rising while its economic earnings are declining, or even worse, when its GAAP net income gets outpaced as well.

The discrepancy between the metrics comes largely from the company removing $8.8 million in non-cash share-based compensation when calculating 1Q25 adjusted EBITDA. For reference, the company’s 1Q25 GAAP net income was -$13 million. The discrepancy should come as no surprise as the company openly admits in earnings releases that “the non-GAAP measures are not and should not be considered an alternative to the most comparable U.S. GAAP measures”.

Figure 2: Adjusted EBITDA vs. Net Income vs. Economic Earnings: 2019 – TTM

Sources: New Constructs, LLC and company filings.

Operating Costs Remain Elevated

The company’s total operating expenses, which include cost of goods sold and selling, general, and administrative expenses have remained high for years. For instance, over the last five years, total operating expenses averaged 106% of revenue.

More recently, the company’s total operating expenses rose from 96% of revenue in 1Q24 to 104% of revenue in 1Q25. The increase was driven by SG&A expenses rising from 36% of revenue to 44% of revenue over the same time.

Consistently Burning Cash

Considering the company’s high operating costs, it should come as no surprise that this company has been and continues to burn cash.

The company’s free cash flow (FCF) has been negative on an annual basis every year in our model (dating back to 2017). On a quarterly basis, the company’s FCF has been negative in 34 of the 36 quarters in our model. The only two quarters with positive FCF occurred in 4Q16 and 2Q18.

From 2019 through 1Q25, the copmany has burned through a cumulative $1.2 billion (29% of enterprise value) in FCF excluding acquisitions.

Figure 3: Cumulative Free Cash Flow Since 2019

Sources: New Constructs, LLC and company filings. 

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