In 2020, market participants have been pouring money into electric vehicle (EV) stocks. And during this earnings season, investors wonder if the risk appetite for shares of businesses in this emerging sector will continue in the coming quarters, too. They also would like to be able to separate the hype from fact and choose robust stocks. Therefore, we will discuss three fundamental fail-safes for picking EV stocks.
Many analysts concur electric cars will disrupt the automobile industry in the near future. The recent consumer interest in “green technologies” has buoyed a wide range of stocks. And this includes even small-capitalization businesses that have gone public only recently.
Overall, this year’s positive momentum behind most EV stocks has also been thanks to Tesla (NASDAQ:TSLA). Year-to-date, TSLA shares are up more than 550%. By comparison, the Dow Jones US Automobiles Index is up about 200%.
So, with all of that in mind, here are three ways (in alphabetical order) to minimize risk in growth stocks:
- Diversification
- Management
- Revenue Growth
Now, let’s dive in and take a closer look at each one.
Fail-Safes for EV Stocks: Diversification
Although Tesla is possibly the first and foremost electric car that consumers and investors think of, it is certainly not the only one. In recent months, there have been many new additions to the list of cars available.
Even companies with little or no revenue, such as Arcimoto (NASDAQ:FUV), Kandi Technologies (NASDAQ:KNDI), Nikola (NASDAQ:NKLA), Nio (NYSE:NIO) and Spartan Energy Acquisition (NYSE:SPAQ), have also entered investor portfolios.
So, how can a retail investor choose among so many names and sectors that are contributing to the growth of EVs? Which one of these new companies is fundamentally a sound investment?
Collectively, the growth prospects of the sector is enticing. Yet, whenever there is potentially a high return, it usually comes with high degrees of risk, too. That said, financial planners and scholars point out, “In order to achieve portfolio diversification benefits, the tradeoff between risks and returns plays an important role in making
investment decisions.”
But how can investors decrease the risk of buying young companies in an emerging field? Well, they could possibly invest in a basket of stocks by buying an exchange-traded fund (ETF). Examples of such funds include SPDR S&P Kensho Smart Mobility ETF (NYSEARCA:HAIL), the Invesco WilderHill Clean Energy ETF (NYSEARCA:PBW) and the ARK Autonomous Technology & Robotics ETF (BATS:ARKQ). In turn, we believe these ETFs may enable investors diversify among a large number of firms.
Management
When evaluating stocks, especially in an upcoming sector like EVs, it is important to look for companies with proactive management. Research on high-growth firms (HGFs) indicates “managers of HGFs seem to more often be highly educated and exhibit prior industry and leadership experience… [L]eadership capabilities in HGFs are pivotal factors for HGFs, perhaps especially so for younger and smaller HGFs founded by a single founder-manager CEO.”
Moreover, the study further points out that general managerial challenges consist “of ‘customer management,’ ‘managing business growth,’ ‘financial management,’ ‘leadership’ and ‘human resource management’ regardless of firm size.”
We have recently seen the importance of management in the case of Nikola, which SEC is investigating. However, short-seller firm Hindenburg Research has recently published a report that said the following:
“Based on our findings, we believe Nikola is an intricate fraud built on dozens of lies over the course of its founder Trevor Milton’s career, which he has parlayed into a $20 billion cloud of smoke and partnerships with some of the top auto companies in the world.”
Although we do not know if these allegations are true, the damage to the shares and the company is real. In fact, NKLA stock is currently down nearly 60% from the all-time highs reached earlier this year.
For the average investor, it may see daunting to dig deep into the details of management. However, buying shares in a firm means investing in its future; Which, in part, is in the hands of its management team. Therefore, we’d urge potential investors to research as much as possibly about a given EV, including its management.
They also could read annual reports, quarterly statements, participate in (virtual) company presentations, search the SEC website for updates on the company and keep abreast of the news as much as possible. After all, it is their hard-earned money that is at risk.
Fail-Safes for EV Stocks: Revenue Growth
From a fundamental analysis perspective, the price of a stock should be the present value of future cash flows. Put another way, what should matter for stock valuation is bottom-line earnings that eventually result in cash payouts.
However, when evaluating nascent sectors and companies that are growing, analysts and investors also pay attention top line revenues that firms generate. Unless a firm generates revenue, there cannot be earnings or eventual profit.
Yet, much of this year’s EV craze has centered around pre-revenue companies. So before hitting the buy button, investors need to study the financial results of these young firms to see when the current hype will actually lead to actual sales. Therefore, there should be more than a simple concept and glossy brochures or fancy websites. Investors should also know the details about vehicle production timeframes, as well as expected revenues from sales of those electric cars.
A recent study by George Beard, published in Oxford Energy Forum of Oxford University suggests:
“Financial factors which influence likelihood to buy an EV include purchase price, running costs, and vehicle depreciation. Consumers are most likely to be influenced by purchase price because this cost is clear and understandable. Consumers tend to place greater weight on costs which affect them immediately, and less weight on costs which will affect them later….”
Put another way, given how competitive and dynamic the market is, investors should decide whether the proposed or current EV will actually sell. That said, one potential way to decrease risks could be to buy shares of already-established car manufacturers.
As a whole, many industry veterans are also moving toward EV production. They include Daimler (OTCMKTS:DMLRY), General Motors (NYSE:GM), Hyundai Motor (OTCMKTS:HYMTF), Volkswagen (OTCMKTS:VWAGY) and Volvo (OTCMKTS:VLVLY), among others. Decades of expertise, manufacturing capabilities and established sales channels will possibly enable them to make a success of their EV operations, too.
On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tezcan Gecgil has worked in investment management for more than two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination.
