A basic tenet of asset allocation is that different investors have different risk tolerances. A small portfolio owned by a 25-year-old single professional should not contain the same stocks as that of a couple in their 60’s heading into retirement.
Even within a portfolio, risks should vary. There’s nothing wrong with allocating a small portion of one’s investments to securities with higher risk and higher reward.
For investors looking for some extra risk, these five lottery ticket stocks offer it in spades. Indeed, all five well could actually end up wiping out shareholders. Whether it’s debt worries, a risky merger or an unproven business model, in each of these cases there are real risks to the company’s equity value, if not its viability.
But all these stocks still have some value in the market — because the potential rewards are enormous as well, for largely the same reasons. Debt is an anchor when a company is struggling; it provides leverage to the equity when that company turns around. Unproven business models can be proven. Turnarounds can drive enormous rewards for patient investors.
To reiterate, these stocks are extremely risky. These are not stocks to buy with money an investor cannot afford to lose. Again, it’s possible that every one of these companies will end up in bankruptcy with a stock price at zero.
But it’s also possible that at least one of these names will provide enormous returns. For investors willing to take on and understand the risks, they are among the market’s most intriguing “lottery ticket stocks.”
Lottery Ticket Stocks: Rite Aid (RAD)
I’ve been a longtime bear toward pharmacy operator Rite Aid (NYSE:RAD). RAD stock has plunged since a planned acquisition by Walgreens Boots Alliance (NASDAQ:WBA) fell through. And bulls have argued that mismanagement under former CEO John Standley is a key reason why.
But as I detailed in September, that simple argument ignores the very real pressures on the pharmacy industry at the moment. Insurers are driving pricing pressure throughout the healthcare industry. Generic drug savings aren’t enough for margins to keep up. Front-end sales are struggling. RAD stock has plunged — but shares of WBA and CVS Health (NYSE:CVS) have fallen as well. Those declines show real industry-wide problems.
The largest reason RAD stock has fallen further than those larger rivals is that its huge debt load has pressured equity value.
All that said, there has been some optimism of late. RAD stock now has nearly doubled from its lows. CVS has bounced 45%, and Walgreens reportedly is considering going private. If the industry really has a better outlook, RAD stock can soar.
The same $3 billion-plus in debt that has pressured RAD stock on the way down can boost it on the way up. A market capitalization of just $530 million shows why. If the company can reduce that debt and the market assigns a higher value to the business as a whole, there’s no reason the RAD stock price can’t double or more from the current $10, and reach a market cap over $1 billion.
After all, Walgreens was offering $180 per RAD share (adjusted for the stock’s reverse split in April), a total consideration of $17 billion. And Rite Aid rose almost 700% from early 2013 to mid-2014, as debt fears receded. That history shows RAD stock can soar.
But remember, too, that Rite Aid’s 2027 bonds yield almost 16% to maturity. That’s a yield that suggests debt investors still see a very real chance of bankruptcy in the next few years. Rite Aid stock now is a highly leveraged bet on its new CEO and a continued recovery for the pharmacy industry. It’s a bet that can pay off big — or leave stockholders with nothing.
Chesapeake Energy (CHK)
I’ve called out Chesapeake Energy (NYSE:CHK) several times as a high-reward, high-risk bet on oil prices. With CHK stock trading at a 25-year low, that’s still the case — though the bet admittedly seems a bit tougher to make.
The headline news from the company’s recent earnings report was that Chesapeake disclosed a so-called “going concern” warning. That’s a legal disclosure that warns investors the company may not be able to satisfy lenders at some point in the next 12 months. Chesapeake CFO Nick Dell’Osso said on the Q3 conference call that Chesapeake could fix the problem by getting a waiver of its debt covenants from lenders, and at least one Wall Street analyst agreed.
But the risk here isn’t necessarily that Chesapeake goes bankrupt in the next 12 months. It’s that it goes bankrupt at some point if oil prices don’t rise. As Will Ashworth noted this month, Chesapeake has been promising positive free cash flow for years now. It still hasn’t delivered. Meanwhile, the debt load continues to hold above the $10 billion mark, and at some point lenders won’t waive another covenant or refinance another bond. Those lenders will take over the company, and shareholders will get nothing.
So what’s the case for CHK at this point? It’s a thin one. CHK stock basically is a call option on a huge jump in oil prices. If those prices rise, Chesapeake’s cash flow skyrockets, and its debt worries ease. The equity value then soars above the current 58 cents per share. If prices don’t rise, the odds are extremely high that at some point, if not necessarily 2020, shareholders are wiped out.
For big-time oil bulls, CHK stock is an intriguing, and very high-risk play. For other investors, it’s a clear avoid.
Gannett (NYSE:GCI) will be the name of the combined company after the USA Today owner was acquired by New Media in a deal that closed this week. And I highlighted what was still New Media stock earlier this month as an intriguing dividend stock under $10.
But it’s not a “safe” yield play, or anything close. Indeed, at this point, NEWM stock is a straight bet on the success of that merger.
And there are huge potential rewards if that merger is the success New Media projects. The company is halving its dividend to help manage the debt used to acquire Gannett, but the stock still will yield nearly 12%. The combined company, under management projections, will generate enormous cash flow, helping it to quickly pay off that debt and drive stable, if not growing, earnings going forward. There’s a real case that even at a multiple of 10x post-merger free cash flow, NEWM stock could rise from a current $6 to $20 or more relatively easily.
The risks are obvious. Newspapers are dying. This is the biggest of New Media’s acquisitions — and that strategy has led the stock to an all-time low after it was spun off from Newcastle (now Drive Shack (NYSE:DS)) back in 2014. The same strategy, and the same CEO, led predecessor GateHouse Media into bankruptcy in 2013.
NEWM stock is a bet on that CEO and on this potentially transformative merger. If it pays off, it’s going to pay off big — but the company’s history highlights the very real risks.
Soliton (NASDAQ:SOLY) stock went absolutely crazy this spring. The catalyst was FDA approval of the company’s tattoo removal device. SOLY stock rose 148% on May 28, and another 43% the following session.
Since then, however, the stock has settled down quite a bit, dropping 61% from those brief euphoric highs. And here, there’s an intriguing high-risk case. Energy-based aesthetics stocks have done well in recent years. ZELTIQ Aesthetics was acquired by Allergan (NYSE:AGN) for $2.5 billion. Hologic (NASDAQ:HOLX) bought Cynosure. Syneron Medical, despite years of disappointment, still went private at a premium.
Only Cutera (NASDAQ:CUTR) remains public among the sector’s major players. And it’s valued at over $500 million despite a consistent inability to drive consistent profits.
Given those peers, Soliton’s $180 million market cap seems potentially reasonable. The company may well have a cutting-edge technology for tattoo removal, a market which obviously can and likely will grow for years. It’s running a clinical trial for cellulite reduction as well, which would make it a player in that huge and growing industry.
Obviously, there are risks here. Soliton still is raising funds, and may dilute shareholders further to do so in the future. The technology may not work. The market is crowded, and a poorly timed recession could shrink that market more just as Soliton is trying to break through.
But there’s a real case behind the optimism that greeted SOLY stock this spring, If Soliton can become a legitimate player in the energy-based aesthetics industry, its market value will be much, much higher than the current $180 million.
Aurora Cannabis (ACB)
It’s probably too early to try and time the bottom in cannabis stocks like Aurora Cannabis (NYSE:ACB). Stocks in the sector continue to plunge, with a disastrous wave of earnings last week hardly doing anything to inspire confidence. ACB stock too fell after a disappointing fiscal-first-quarter report. Though, the sector did get some relief as Federal lawmakers made some steps toward legalization.
However, it can get worse. I argued just this month that investors should avoid Aurora stock. The company’s convertible debt now has to be paid in cash, which raises funding worries. Selling prices in Canada are collapsing. Aurora now has a far-flung manufacturing operation with significantly lower revenue potential.
All that said, for investors willing to time the bottom at some point, Aurora probably is the play. Aurora’s aggressive strategy long has made it likely that it would be either the biggest loser, or the biggest winner, in cannabis. The latter scenario still isn’t completely impossible.
If the Canadian market can get fixed, and/or other countries move toward national recreational legalization, sentiment toward pot stocks can improve. The broad case for stocks in the sector has been that, eventually, cannabis would be a huge, multi-national, regulated industry. That’s still on the table.
Aurora may have near-term funding worries, and it’s likely there are going to be a number of bankruptcies across the sector in the coming years. But if Aurora Cannabis can avoid being a name on that list, the long-term rewards for investors buying at the bottom can be huge. The one issue right now, however, is that there’s little evidence to suggest the bottom is in just yet.
As of this writing, Vince Martin has no positions in any securities mentioned.