At this point we sound like a broken record, but, once again, the market is reaching new highs. The catalyst this time? November’s inflation data released Wednesday morning was in-line with expectations, which increases the likelihood of an additional interest rate cut next week.
Markets, especially the meme-stock heavy NASDAQ, bounced from the jump, with big names such as Apple, Amazon, Meta, Alphabet, and Tesla all reaching record highs. At the time of this writing, the NASDAQ had crossed 20,000 for the first time ever. Soaring prices are great for traders and speculators, the kind that move in and out of positions quickly and drive up trading volumes.
However, for long-term investors, those looking to find good companies at good valuations, soaring stocks makes finding real value more difficult.
Investors should be careful not to get caught up in the hype.
This week’s Danger Zone pick has directly benefited from the market hype and speculative trading in both equities and cryptocurrencies. In fact, its stock is up nearly 200% this year alone. The problem is that this move is not supported by the fundamentals of the business.
Investors thinking now’s the time to buy might want to think again. After the run up, this stock presents a perfect example of priced for perfection and more as the implied expectations for future profit growth look nearly impossible to achieve.
Below is a free excerpt from our latest Danger Zone pick, published today to Pro and Institutional members. We’re not sharing the name of the company because that’s for our paying clients. However, we think you’ll greatly enjoy the research because it provides insights into how hard we work to give you the best ideas and the smartest warnings.
We hope you enjoy it. Feel free to share with friends and family, and we hope your portfolio stays safe from stocks like this one.
We first put this stock in the Danger Zone in July 2021 prior to its IPO and later named it a Zombie Stock in August 2022. Our thesis highlighted the firm’s slowing growth, lack of scale, conflicted business model, more profitable competition, and overvalued stock price.
Since our original Danger Zone report the stock has outperformed as a short by 39%, falling 2% compared to a 37% gain for the S&P 500.
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Today, the company has successfully capitalized on booming investor demand for options and cryptocurrency to generate positive FCF in three of the past four quarters and over the trailing-twelve-months (TTM) ended 3Q24. As a result, the company no longer qualifies as a Zombie Stock, but that doesn’t mean it’s a stock with good risk/reward.
What’s Working for the Business
The spike in demand for options and cryptocurrency trading has boosted the company’s revenues. From 2021 through the TTM ended 3Q24, the company grew revenue 10% compounded annually. At the same time, the company has successfully incentivized investors to move assets to its platform.
The company also substantially cut general and administrative expenses to lower operating expenses as a percent of revenue from 140% in the nine months ended September 30, 2023 to 74% of revenue in the nine months ended September 30, 2024. The decline in expenses helped the company improve its net operating profit after-tax (NOPAT) margin from 17% in 2023 to 32% in the TTM ended 3Q24.
These improvements are substantial, to be sure, and the stock price has soared. However, the rise in share price went well beyond what was warranted by the fundamentals of the business.
What’s Not Working for the Business
The improvement in the business still leaves the company as a small player in a market filled with giants. Traditional peers also achieved significant growth in assets and client accounts over the past few years, so much so that the company remains at the bottom of the pack.
All is Well in a Booming Market – As Long as You Keep Trading
In our original report we argued that the company needed to significantly increase its brokerage assets to build a base source of interest revenue in the event that payment for order flow (PFOF) was ever banned or diminished.
The company has successfully done just that, as noted above, and transaction-based revenues, represent a smaller portion of the company’s total revenues than in the past. However, transaction-based revenues remain a much larger portion of the company’s revenue relative to peers, which means the company’s revenue growth is much more reliant on increased trading activity. The company admits as much in its 3Q24 10-Q:
“Our transaction-based revenue is sensitive to and dependent on trading volumes and therefore tends to decline during periods in which we experience decreased levels of trading generally.”
….there’s much more in the full report. You can buy the report a la carte here.
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