These 2 actions carry a lot of risk, but their advantage is enormous
As an investor, I enjoy maintaining a portfolio of world-class blue chip companies that reward me with dividends for owning their stocks and allow me to sleep soundly at night knowing that I own a small portion of a big company. But in a well-balanced portfolio, it’s also possible to add a smaller allocation of certain high-risk stocks that have the potential to increase your returns over time if they materialize.
Taking on a higher risk generally implies a higher potential return, as investors need to be properly compensated for the risk they take. Risk can take many forms – perhaps the company has worrying debt. Maybe his core business is in decline or the stock is trading at a nosebleed multiple.
Here are two high-risk, high-return stocks that have the potential to provide outsized returns for risk-tolerant investors as part of a well-balanced portfolio.
carvana (CVNA 40.07%) is arguably the ultimate high-risk, high-reward stock. Shares of the internet-native auto dealership are down 86% year-to-date as rising interest rates and fears of a recession dampened market appetite for “historic stocks”. who do not make a profit. Moreover, many observers fear that it will live on borrowed time because it will not be able to service its high debt load.
Sounds like a lot of risk, right? He is. But here’s why the payoff is also potentially huge – Carvana is showing skyrocketing revenue and unit volume growth while establishing a strong footing in a $1 trillion end market.
Buying a used car is one of the average consumer’s least favorite experiences, probably on par with getting a root canal. The legacy used car industry is a massive market that is ripe for disruption. Carvana’s platform, which allows users to buy and sell vehicles online, certainly shakes it up.
The platform is easy to use (in my experience) and convenient as Carvana sends one of its trucks to pick up the vehicle from you (if you are the seller) and can deliver it right to your driveway (if you are the buyer). Users don’t have to go to a used car park or haggle with a salesman. Moreover, with more than 70,000 vehicles available on its platform, Carvana offers a selection far superior to what a buyer would get by going to their local dealership.
The company has already become the second largest used car dealership in the United States in just eight years of existence, so it’s clear that this model resonates with consumers. Additionally, Carvana has been growing both revenue and unit volume at a breakneck pace over the past few years. Carvana’s revenue was just under $2 billion in 2018, but grew to over $12.8 billion in 2021. The company sold 94,000 cars in 2018 and 425,000 in 2021 .
That revenue and unit growth is significant, but the bears are right that it means nothing if the company ultimately can’t turn a profit. But the good thing is that Carvana’s management team aren’t sitting in the sand – they are well aware of this and are working to slow down the company’s cash burn and prioritize positive cash flow. .
Carvana plans to reduce SG&A expenses, lower capital expenditures and improve the unit economics of every vehicle purchased and sold. The company has made steady progress on gross profit per unit over the past few years, rising from just $206 in 2015 to $4,537 in 2021.
Given what Carvana has accomplished over the past few years, there is reason to believe that it can figure it out and execute this plan, in which case the company would be able to not just survive, but thrive. It’s as risky and highly rewarding as it gets, and I’ve allocated a small portion of my overall portfolio to it, which isn’t more than I’m willing to lose.
2. Dutch Brothers
My second high-risk, high-return stock is dutch brothers (BROS 4.25%). As a recent IPO with big money and little debt, Dutch Bros isn’t high risk the way Carvana is and faces no existential threat. But the company is trading at a sky-high valuation of more than 90 times forward earnings in a market that has lost its appetite for these multiple-multiple stocks and will therefore punish them with a sell for any missteps, which is why the he stock is down nearly 50% since the start of the year. There’s still plenty of risk ahead, especially at a time when inflation and high gas prices seem like a headwind to demand.
But the potential reward here continues to be enticing. The West Coast-based coffee and energy drink supplier with names like Vampire Slayer and Double Rainbro is a hit with young consumers and growing its store count. Dutch Bros is expanding beyond its home base on the west coast as it seeks to reach its long-term goal of 4,000 locations nationwide.
Dutch Bros recently opened its first locations east of the Mississippi River in Tennessee, and if its popularity in the western United States translates to the east coast, there’s a huge market opportunity ahead. With around 600 locations now, there is a lot of execution risk and tastes may change over time. However, if Dutch Bros continues to execute its plan and becomes a household name or the next Starbucksearly investors will be rewarded for tolerating some risk.
For investors with a diversified portfolio who can handle some risk, the benefit of a few well-placed high-risk, high-reward positions in a portfolio can be significant.
Michael Byrne holds positions at Carvana Co. and Dutch Bros Inc. The Motley Fool holds positions and recommends Starbucks. The Motley Fool recommends the following options: Short Calls October 2022 at $85 on Starbucks. The Motley Fool has a disclosure policy.