Beware those who bear gifts of high valuation and no profits!
That's the key lesson from the latest high-profile disasters on our market, which are putting the spotlight uncomfortably on other emerging blue-sky stocks that have enjoyed a magnificent rally over the past year.
One such stock is Wattle Health Australia Ltd (ASX: WHA), after an Australian Financial Review article questioned if the infant formula and health products supplier is deserving of its near $200 million market cap following the magnificent fall from grace of Big Un Ltd (ASX: BIG) and GetSwift Ltd (ASX: GSW).
Just as with Big Un and GetSwift, the share price of Wattle Health had increased multiple-fold over the past year, but with little or no profit to show for the valuation upswing.
In Big Un's case, it did demonstrate a large increase in cash receipts, although that turned out to be financing from a related party.
Wattle Health's share price surged by 12-fold from a low of 20 cents before it crashed 15.4% in late afternoon trade to $2.03.
That's an even more incredible increase than other high flyers in the sector like A2 Milk Company Ltd (ASX: A2M), Bellamy's Australia Ltd (ASX: BAL) and Bubs Australia Ltd (ASX: BUB), which are "only" up by around 300% to 400% over the same period.
Wattle Health posted a net loss of $13.1 million in 1H FY18, compared to a net loss of $2.5 million for the same time last year.
It is worth nothing other outperforming small stocks outside of the sector with widening losses as well. Some come from the medicinal cannabis sector, another hot area for investors, that includes Auscann Group Holdings Ltd (ASX: AC8), with its $219 million market cap and ballooning first half net loss to $4.8 million from $1.3 million in 1H FY17.
But some would also argue that focusing only on past earnings and not the future will mean you'll never be able to capture the early upside from market heroes like online property classifieds company REA Group Limited (ASX: REA) and accounting software company Xero Limited (ASX: XRO)!
Perhaps one way to try to pick the heroes from the zeros is to re-look at the way you analyse companies.
Serious investors are great at looking at the profit and loss (P&L) and cashflow statements, but ignore pretty much everything else.
There are three other things investors should look more closely at:
- Issue of options and shares: In particular, look at free or low-price options to consultants and related parties.
- Share register: It's not only the names of the biggest shareholders, but the movement in their shareholdings that is telling.
- Management background: Always ask where the senior executives have come.
One golden rule I have to investing is ignoring FOMO (fear of missing out) as that can drive you into shares you may not normally look at. Living to fight another day is far more important than picking the next 10-bagger.
Remember, it's not just the winners you pick that will make a big difference to your portfolio returns over the long-term, but the losers you avoid.
This doesn't mean you shouldn't be on the lookout for stocks that are primed to outperform. The experts at the Motley Fool have identified three disruptors that are set to take-off over in 2018 and beyond.
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