When a stock like Beyond Meat rockets higher like it has since its IPO, turning in the best performance of any new stock market issue in 2019 — up more than 550% — there’s a lesson to be learned. I’m just not 100% sure anyone wants to hear it. It is not the lesson about being so smart you knew exactly which hot IPO stock to get into.
One of the potentially worst things that can happen to a new investor is scoring a huge gain the first time they invest in an individual stock. That doesn’t mean the best thing a first-time investor can do is lose money. Of course not. But quick gains can give new investors the illusion that investing for quick gains is an actual process, and an easy one. It is not, and it usually backfires.
You may know someone who tossed a few thousand bucks into shares of Beyond Meat during this amazing run. My CNBC editor told me about a millennial co-worker who told him about a personal trainer friend who bet his first-ever market money — $2,000 — on Beyond Meat and made a “quick” $800 in just a few days. And I am fairly certain that is not a rare case.
That is not surprising. Beyond Meat has been hard to miss if you follow headlines. The stock has been on a wild ride, and there are reasons to be excited. Here are a few of them.
Consumer acceptance of plant-based meat substitutes has become very strong with many major restaurant chains rushing to add these items to their menu. There is definitely a trend toward plant-only diets. There are about 7.3 million vegetarians in the U.S., a little more than 3% of American adults, according to Vegetarian Times.
The numbers grow larger when you look at younger segments of the population — millennials at 12%, and it could rise even higher for Gen Z individuals. Demographics favor the trend of meatless substitutes. And right now market mechanics are very favorable for Beyond Meat because it’s the only game in town if you want to invest in this space.
Bites and buzzes
But it is important to have a perspective on past rocket rides. Even professionals have a lousy track record when it comes to making quick capital gains on a steady basis. Investing in individual stocks is risky business and over the long-term, investors are better served by keeping expectations in check and educating themselves on the fundamental corporate financials that influence stocks rather than thinking the chart only goes up and to the right. This is especially true when the stocks reflect emerging trends which are carrying a lot of buzz, and the plant-based protein burger craze is trending.
Cannabis stock Tilray is a good recent example. Its shares were over $200 last September. Now Tilray shares are roughly $40. The fall has been as spectacular as the rise, putting on full display the greater fool theory — that it is possible to make money by buying securities, whether or not they are overvalued, because there will always be someone willing to pay a higher price when you sell them.
Fundamentals like earnings and revenue were never part of the evaluation process. People were buying on the early gains and the hype that the company would somehow play a major role in the future of mankind. The lesson in Tilray’s comedown: Market prices usually catch up with the fundamentals and not the other way around, if given enough time.
Let me make one thing clear: Tilray has done okay. It went public at $17, and its first trade opened around $23. At $40 today that is still a healthy gain for investors, but only for long-term investors who never expected the $200 share price to be hit within a year when they bought in the first place.
The toughest thing about judging a hot stock is that the metrics we investors use to judge these are temporarily suspended. You may be familiar with ratios like P/E (price to earnings ratio), P/S ratio (price to sales ratio) and profit margin. But when a stock jumps so much and so quickly that its own ratios can’t keep pace with it, it typically means that the stock is going up on non-financial catalysts. What could these be? Investor euphoria, extreme optimism, and crazy high expectations that fundamentals to match won’t be far behind.
Momentum vs. fundamentals
I would never say a company that isn’t making money yet is a company investors have to avoid. That would have ruled out some of the greatest IPOs of the technology era. But when a stock rapidly ascends for more than a few days, it is considered a “momentum” play, or “momo” if you want to use Wall Street lingo. Stock prices are generally ahead or behind the fundamentals of the underlying company, which is why stocks go up and down in the first place. But momentum stocks general outdistance the stock price by such large degrees that when they turn back toward the company’s fundamentals, it causes devastating losses for the Johnny Come Lately investors.
In the near term, when what is called the “lock up” period for company insiders ends, putting their shares out on the open-market adds to what has been a limited supply of Beyond Meat shares, and that can pressure the stock price. There also could be an IPO of plant-based protein competitor Impossible Burger, which could pull current Beyond Meat investors into the new hot trade.
The only way to avoid this, in my experience, is to be in stocks whose price isn’t too far above fundamentals. If your typical food company has a P/E ratio under 15 and BYND is melting up without any earnings, it is a sign — not a guarantee — that is going to reach the end of investor enthusiasm and come back down to earth. Food stocks, which are part of the consumer staples sector, typically trade at lower valuations than that of the overall market due to those exhibiting less earnings growth.
Want to look up Beyond Meat’s price to earnings ratio? You can’t, because a company that has no earnings yet can’t have a P/E ratio. Same for Tilray. Price to sales ratio on Tilray is about 65 times sales; Beyond Meat is trading at about 45 times sales. Compare that to some of the largest consumer and fast food companies: Coca-Cola (6.7 times sales); Kellogg (1.4); Unilever (2.8); Nestle (3.3); McDonald’s (7.6).
Another case in point is Tesla. There is no time I can recall in my career (since 1990) of a company that makes such fine products but whose fundamentals are simply not enough to maintain a high stock price. BYND, with its super high price to sales, is like the TSLA of food stocks. But that doesn’t mean that if the future of cars is electric, then the future of food is all plant-protein based. And investors who have stuck with Tesla since the IPO have been rewarded — though extreme volatility has tested their investing patients. Tesla went public at $17 and even though the recent headline flow is about the massive decline in shares of Elon Musk’s company, its current share price over $220 has been a winner for long-term investors.
My intention is not to pick on stocks. My goal is to fill you in on a few of the qualitative factors that create these insane short-term moves that can’t be tied back to quantitative factors.
Some qualitative factors are for real: first-mover advantage, products that are loved by consumers, and brand name recognition. Beyond Meat has all three of these key qualities. Same for Tesla and Netflix. But eventually, all hot companies run out of eager buyers who rely on nothing but momentum and the real test comes into play. Many plunge in price and recover after enough time goes by to convince investors that their fundamentals — the quantitative factors that can be measured with actual numbers — can justify an ascending stock price.
The world’s best example, in my opinion, is Amazon. It was a home fun after it went public. It plunged along with the rest of the NASDAQ in early 2000s tech wreck. Amazon was as low as $7 a share in 2001 after trading near $100 in 1999. Once the kind of investors who like to see revenue and EBITDA (earnings before interest, taxes, depreciation and amortization) got focused on the company, it became one of the world’s biggest. But it is important to realize that took years to happen.
Valuations are determined by investors and being in on a hot IPO does not make an investor. The point is not to tell investors to stay away from any specific stock. It is to remind them that the stock market is a buyer beware environment and you need to do your homework. Looking at a post-IPO stock chart that has skyrocketed does not count as research. Or to put that in Wall Street lingo, past performance is not a guarantee of future results.
Disclosure: NBCUniversal and Comcast Ventures are investors in Acorns.