"Never invest in a business that doesn't make a profit".
This is a great rule to follow. But in my view, there are two types of stocks to invest in, each requiring a slightly different focus.
Core holdings are the established businesses which should make up the bulk of your portfolio. Ideally, they are profitable and paying out a growing stream of dividends. A durable competitive advantage and an industry tailwind are the things to look for.
Speculative stocks, on the other hand, have a promising future but may not yet be profitable. They should have fast-growing earnings, a clear path to profitability and the right management to get them there.
Although they come with higher risk, a diversified allocation to speculative stocks can be rewarding. After all, it is future profits that you are interested in. Nearly all of the most profitable companies on the ASX were unprofitable once, and have delivered huge gains to those who invested early.
Here are two speculative stocks to consider today:
AHAlife Holdings Ltd (ASX: AHL) is based in New York and curates an online market for luxury goods with nearly 800,000 users. It is focusing on mobile internet and has developed an interesting new application for gift giving.
AHA uses a drop ship model, meaning it stocks no inventory, but makes around a 50% margin on sales from its 3,800 sellers across 45 countries.
It raised $20 million and listed on the ASX in July last year. Shares have fallen from 45 cents to 20 cents currently. This gives AHA a market capitalisation of around $30 million.
Full year sales for 2015 were $8 million. Sales for the March 2016 quarter were $2.1 million, an increase of 140% over March 2015.
AHA has nearly $9 million in cash and has a good chance of reaching positive cash flow in 2017 if it can maintain its growth trajectory.
1-Page Ltd (ASX: 1PG) is another US-based tech company which has been struggling lately. It was founded in 2011 and has developed software designed to streamline the process of hiring staff.
After listing in October 2014 it shot up to over $5 a share in late 2015. Since then, the price has collapsed around 90% to 37 cents. This represents a market capitalisation of $43 million.
Investors have been spooked after recent reports suggested revenues aren't growing as quickly as previously expected. The company is still a long way from reaching profitability.
1-Page is burning around $2 million a month, but has around $40 million in cash (at 30 April), so will hopefully be able to fund its growth for the next few years without raising any more capital.
Time to buy?
Both AHA and 1-Page require significant growth before profitability is reached, but might represent decent value at current prices if they can execute on their plans. However, both have plenty of competition and face an uphill battle.
Diversification is key when investing in speculative stocks – it would be hard to argue the case for anything larger than a 1% or 2% portfolio allocation for either business.
