5 Second-Rate Stocks to Sell While You Still Can

This article is an excerpt from the InvestorPlace Digest newsletter. To get news like this delivered straight to your inbox, click here.

We’re officially in a bull market. Last week, the S&P 500 closed 20% above its recent lows and the American Association of Individual Investors (AAII) sentiment index hit its highest level since 2021.

As InvestorPlace analyst Luke Lango notes, slowing inflation and rising markets tend to signal even greater gains to come. 

Yet, our editors at InvestorPlace.com, our free news site, have also seen a recent surge in reader interest about stocks to sell.

Oil…

Crypto…

Even artificial intelligence and electric vehicle stocks.

That’s because experienced investors know that some companies will fall back to Earth once the new bull market ends. These second-rate stocks ride the coattails of successful firms on the way up, only to crash back down once the market cools.

That’s why our writers have been busy identifying the second-rate companies to sell immediately. Let’s take a look at their top picks…

Lucid (LCID)

At first glance, there’s a lot to like about electric vehicle company Lucid Motors (NASDAQ:LCID). The company was a superstar SPAC merger and is led by a highly experienced team of former Tesla engineers and other automotive veterans. Its flagship Lucid Air won MotorTrend’s 2022 Car of the Year award for its “meticulous design and unparalleled electric capabilities.”

This week, however, Louis Navellier and his team warn investors that Lucid’s recent Chinese ambitions signal an underlying issue with its sales figures. They say:

Lucid only delivered 1,406 vehicles from its Arizona factory during 2023’s first quarter.

Does the company miraculously expect to do better in China? [Head of China operations Zhu] Jiang’s confidence isn’t the same thing as a specific, well-documented road map to success in a highly competitive market.

In other words, Lucid’s sudden pivot into the Chinese market is more an act of desperation than a carefully planned strategy. The Chinese market is already relatively saturated with high-end players, including Nio (NYSE:NIO), Xpeng (NYSE:XPEV), Li Auto (NASDAQ:LI) and Tesla (NASDAQ:TSLA) itself. Buyers also prefer luxury SUVs to sedans — an area where Lucid has no experience.

InvestorPlace.com writer Faisal Humayun agrees with the assessment. The former LCID bull highlights how intensifying competition and disappointing growth have turned him negative about the company’s prospects. A recent $3 billion capital raise underscores the company’s financial woes.

Though Lucid may eventually become a key Tesla competitor, its strategy today looks more in line with that of a second-tier company.

Altria (MO)

Dividend-seeking investors have long relied on “sin” stocks for regular income. Tobacco, alcohol and gaming stocks have traditionally sold at a discount, which makes their dividend appear larger relative to their market prices.

That’s made Altria Group (NYSE:MO) — a 2003 rebrand of Philip Morris – a tempting investment. The tobacco company offers a high 8.5% dividend yield and trades at a stable 0.63 beta.

But don’t be fooled by these rosy figures.

This week, InvestorPlace.com’s Joel Baglole highlights how Altria’s apparent stability masks “chronic underperformance” at the once well-managed firm. In 2018, the tobacco company spent $13 billion to acquire e-cigarette company Juul, only to lose 95% of its investment after regulators banned Juul’s products. Altria also spent $1.8 billion on cannabis firm Cronos. The acquired firm now trades as a penny stock.

At the same time, reduced tobacco consumption continues to chip away at Altria’s financials. The company only generated $8.05 billion in free cash flow last year, a 2% decline from the year before. Wall Street analysts have also been steadily reducing their earnings per share (EPS) estimates since early 2022. It’s hard to maintain profits when revenues are in secular decline.

Altria may once have been a top-tier dividend producer. But shifts in smoking habits (and poorly thought investments on Altria’s part) mean this dividend aristocrat is quickly turning into a second-rate bet.

Bitfarms (BITF)

Bitfarms (NASDAQ:BITF) is a Toronto-based cryptocurrency miner that once traded as high as $8.50 per share. Excitement over the company’s “green” Bitcoin (BTC-USD) mining helped the Canadian firm achieve top-notch market valuations. At the time, Bitfarm’s use of hydropower seemed like the future.

But it turns out that the capital-intensive nature of Bitcoin mining isn’t particularly profitable, no matter what source of energy you use. High capital investments, paired with volatile crypto prices, mean that Bitfarms has never generated a single year of positive free cash flow, according to data from Thomson Reuters.

This week at InvestorPlace.com, Josh Enomoto writes how he is throwing in the towel on crypto mining firms.

In its place, this early crypto supporter recommends higher quality tech stocks, knowing that AI and quantum computing are far better bets than the second-rate world of crypto mining. When it comes to generating consistent profits, having low capital overheads makes the most sense.

PetMed Express (PETS)

Joel Baglole also warns investors about PetMed Express (NASDAQ:PETS), better known as “PetMeds,” this week. The online pet pharmacy traded at $40 during the Covid-19 pandemic but has recently seen a significant slowdown in demand. The company reported a 5.4% decline in quarterly revenue in its latest quarter.

Meanwhile, firms like Chewy (NYSE:CHWY) and Petco (NASDAQ:WOOF) have done far better, with growth ranging between 5% to 15%. 

At its core, PetMeds finds itself stuck between these two behemoths. Chewy operates an unusually efficient marketing funnel, spending between 6% and 7% of revenues on advertising to generate 13% to 15% year-over-year growth. (PetMeds achieves only a third of that efficiency). Meanwhile, Petco remains hypercompetitive from its extremely low costs. The brick-and-mortar pet store generates gross profits that are over a third higher than PetMeds’ while seeing similar overheads.

That means PetMeds’ high dividend will unlikely last for long. Investors are better off buying the top online pet company (Chewy) or the top brick-and-mortar one (Petco) than settling for PetMeds.

Devon (DVN)

Devon Energy (NYSE:DVN) rounds out our list of second-tier companies this week after announcing weak 2023 production guidance and higher-than-anticipated capital expenditures.

This marks a stunning turnaround for what was once one of America’s lowest-cost hydrocarbon producers. In 2019, the company divested its high-cost Canadian oil sands business and merged with WPX Energy in 2021 to gain access to lower-cost assets. At the time, Rystad Energy noted that Devon had the lowest breakeven costs associated with undeveloped reserves.

But these high returns on capital seem to be coming to an end. This week, Faizan Farooque notes how the energy exploration firm raised its capital spending from $3.6 billion to $3.8 billion to offset production losses. Wall Street analysts have also trimmed their 2023 EPS estimates from $8.90 in January to $6.30 today on lower energy prices.

Louis suggests that investors consider other energy stocks instead. In his latest quantitative updates, he identifies a handful of energy companies with improving outlooks in this tough environment.

The Curse of Being Second-Best

My family hates sending me out grocery shopping. They’ll often give me a list of ketchup… cereal… salsa…

… and I’ll come back home with store-brand versions of everything.

I barely know the difference between Heinz and Hunt’s.

But if you ask me about the companies I buy… that’s an entirely different matter. That’s because buying top-tier companies matters.

We see this happen repeatedly. Dominant companies like Amazon will eventually beat the eBays. Uber now outperforms Lyft by a wide margin. And hundreds of former chipmakers have fallen to the likes of TSMC.

That’s because small profit differences tend to magnify over long periods, as I explain in my Perpetual Money Machine Strategy. If a dominant company can charge 10% more for a product, for instance, that extra cash can go into improving quality, increasing production, or greater advertising. That, in turn, helps the dominant company generate even more profits, and so on.

The opposite is true for second-rate companies. These firms have less money to reinvest in research and development, putting them on a downward spiral.

Today’s bull market will make these upstarts seem like superstars, at least in the short run. This week, a 4-week-old startup managed to raise 105 million euros in a growing frenzy surrounding AI technologies. But once the tide goes back out, investors should be sure their high-priced acquisitions are winners in their fields.

That’s part of what analysts like Eric Fry do. For example, Eric recently traveled to San Francisco to visit the “birthplace” of AI… and to scope out which are the best AI investments to make right now.

Eric tells me that every American deserves to see what’s happening there because Elon Musk’s “Project Omega” is guaranteed to affect all 331 million Americans one way or another.

Click here now and learn how to prepare.

As of this writing, Tom Yeung did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Tom Yeung is a market analyst and portfolio manager of the Omnia Portfolio, the highest-tier subscription at InvestorPlace. He is the former editor of Tom Yeung’s Profit & Protection, a free e-letter about investing to profit in good times and protecting gains during the bad.

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