Risk management is a cornerstone of investing. Most people believe the concept involves identifying, evaluating, and prioritizing the safest investments and then curating a strategy to pour capital into only the most reliable companies. However, investors willing to invest in risky stocks stand to make a lot of profit.
That’s why keeping an eye on the beta is very important since it measures the volatility – or systematic risk – of a stock versus the entire market. If you are willing to stomach the risk, then you can go ahead and invest in risky stocks and potentially enjoy the bumper gains. But if you are the kind of investor that likes to play it safe, then perhaps this list will act as a guide to make sure where you shouldn’t invest.
Joshua Della Vedova, an assistant professor of finance at the University of San Diego School of Business, told InvestorPlace about the risks facing several sectors due to the novel coronavirus. “The COVID-19 pandemic has been an enormous shock to society and the economy,” he wrote in an email. “From a purely economic perspective, there are numerous changes to both business operation and financial markets that have taken place and will continue to play a part in the economic recovery. By directly observing the sector performance over the last year, you can see the best and worst performers. As expected, the best performers are technology, internet services, and logistics. In contrast, the worst performers are energy, airlines, and leisure products.”
“From a purely financial perspective, firms that are carrying substantial amounts of debt and have had a business disruption, such as airlines, will suffer the most. Despite historically low-interest rates, refinancing of these debts may cause significant insolvency risk if this crisis is increasingly protracted. Despite many of these firms receiving bailouts, there may be a push for nationalizing airlines or other firms that can’t continue with the current level of losses.
“If there is no vaccine and continued global lockdowns, the current recovery may begin to slide back downwards. Many firms are running in their most barebones state and at this rate can’t continue for another year or two. However, on a positive note, if there is an effective vaccine it may be back to business with a whole year of pent-up demand for travel and leisure that may make 2021 truly a great year.”
Beta and Risk
As a rule of thumb, companies with a beta of more than 1.5 are considered higher risk. Since these stocks tend to be at least 50% more volatile than the S&P 500, these stocks have the potential to be multi-baggers or clunkers.
Here are three risky stocks you should keep your eye on:
Risky Stocks: Boeing (BA)
Several sectors are still reeling from the effects of Covid-19. One of the hardest-hit industries is aviation. Unsurprisingly, BA stock is oscillating wildly. However, what will surprise readers will be that the swings are not new. In 2018, BA stock went past $350 per share, eventually going past $400 a year. Shares then swung between $340 and $380 before the pandemic led to a crash.
BA stock trades around $151 per share. Many people would think it’s a bargain, considering the company’s history. But there are problem spots for Boeing that you need to consider.
Firstly, the company is saddled with more than $54 billion in debt. Cancellations are also an issue. There were 108 in April. And although the cancellations rate slowed in July to 43, no new orders are coming in.
Don’t get me wrong. I admire the management for making some important decisions recently. Those decisions include grounding its most popular, narrow-body 737 MAX fleet.
After the terrible tragedies leading up to the grounding, several corporate governance initiatives were put in place to ensure any further issues arose. And we are expecting deliveries to resume during Q4 2020. However, BA stock remains one of the more risky stocks around, considering that commercial travel will take years to return.
Ashford Hospitality Trust (AHT)
Ashford Hospitality Trust is a real estate investment trust (REIT) that pours capital in upper upscale, full-service hotels. Like most REITs, the company is bound to distribute at least 90% of its taxable income to shareholders annually in the form of dividends.
It sounds like a great investment, right? Well, not quite. Hotels are one of the many business segments getting hammered due to sluggish local and international travel. That’s why AHT stock is now considered a laggard rather than a very safe investment.
With revenue down almost 90%, the road to recovery is a long, arduous one. Moving forward, the externally managed REIT will have to concentrate on preserving liquidity and reducing cash burn. I don’t think that will be an easy task. As of the last quarter, the company had cash and cash equivalents of $165 million. Meanwhile, AHT has $95 million of restricted cash on its books.
Total cash burn in the last quarter came to $60 million, and this doesn’t include the $85 million the company did not end up paying on tax expenses.
Long story short, the company is bleeding money, which puts it on our list of risky stocks. Only the most risk-averse investors should proceed with this one.
United Rentals (URI)
United Rentals is a sure bet under normal circumstances. It’s the world’s largest equipment rental company. So why is it on the list of risky stocks?
Well, here is where it gets interesting. URI stock has shown extreme volatility over the past year, with a 52-week high of $203.57 and a 52-week low of $58.85. Estimates are for the company to make a comeback next year, once the impact of Covid-19 subsides.
On the bright side, the company is a market leader in North America, with about 13% of market share as of 2019. So, once we start to see demand move northward, positive headlines will emerge from the company. We are already seeing a resurgence of sorts, with the Q2 results better than the first quarter.
United Rentals reported EPS of $3.68 on a non-GAAP basis, beating consensus estimates by $1.75. Meanwhile, revenue managed to beat consensus by $100 million. URI has a very diversified client mix, and that certainly helps amid a pandemic. Residential construction represents 5% of revenue and non-residential construction makes up 48%, with industrial firms contributing the rest.
URI stock trades at 11.48 forward price-to-earnings from a valuation perspective, a 43.56% discount to the sector median.
On the date of publication, Faizan Farooque did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio.