If You Own These 3 Growth Stocks, You Might Want to Rethink Your Position

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When investing in growth stocks, you typically are looking for a high slugging percentage, meaning that even if quite a few of your picks are duds, the winners more than make up for the losses because of how much they can compound over the long term. With that being said, it is important for everyone to criticize their holdings to try and trim any weeds. 

Three popular growth stocks in which investors may want to rethink their positions are Robinhood (NASDAQ:HOOD), Skillz (NYSE:SKLZ), and Opendoor Technologies (NASDAQ:OPEN)

Image source: Getty Images.

Robinhood

Robinhood is an investing/trading app popular with younger people, and it has grown like a weed since the start of the pandemic. In the quarter that ended in June, Robinhood grew monthly active users (MAUs) 109% to 21.9 million, and assets under custody (AUC) increased 205% to $102 billion. This growth translated to revenue growing 131% year-over-year in the quarter to $565 million.

Sounds great, right? Well, if you look a bit deeper into the report, you can see that this growth is likely not sustainable. Robinhood makes money by selling its users’ trades, so the more people trade stocks, options, and cryptocurrencies, the more money it makes. In Q2, options trading revenue increased 48% to $165 million, while stock trading revenue actually decreased 26% to $52 million. The majority of Robinhood’s growth in Q2 came from cryptocurrency transactions, growing from a tiny $5 million last year to $233 million in this period. That doesn’t seem very sustainable because 62% of Robinhood’s Q2 cryptocurrency revenue came from Dogecoin, which was created as a joke and relies solely on trading volume to have any sort of “value.”

Robinhood even mentioned this in its earnings report, saying that its revenue relies on the retail trading sentiment around stocks and cryptocurrencies, which is not predictable and should not be expected to continue, even into the third quarter.

With a market cap of $36 billion, only $1.67 billion in trailing-12-month sales in ideal market conditions, and a long history of net losses, it is hard to see why anyone would buy Robinhood stock right now. 

Skillz

Skillz is a mobile gaming platform focused on competitive esports with games like solitaire, bingo, pool, and many others. It tries to foster a competitive atmosphere where people can bet and win real money by going head-to-head with others on these mobile games. The problem is, so far it seems to be struggling to get mass adoption with its products.

For 2021, the company is guiding for $389 million in revenue, which would be 69% growth from 2020. That looks good on its face, but investors should remember that some of this is growth from acquisitions and that revenue growth has slowed substantially in recent quarters, from 95% year-over-year in Q4 2020 to only 52% in Q2 2021. This slowdown in growth is likely a big reason Skillz stock is down 55% year to date.

Investors may also be looking at app store rankings, where Skillz is clearly struggling. On the Apple App Store, the Skillz app only has 261 ratings, even though it compares itself to top mobile games like Candy Crush, which has over 2.2 million ratings on the App Store. Yes, Candy Crush has been around a lot longer than Skillz, and Skillz still could grow into a dominant player in the mobile gaming market, but this discrepancy in popularity is a huge cause for concern.

With a market cap of $3.5 billion and a short history of heavy share dilution,  Skillz stock is pricing in a lot of growth that may evaporate in coming quarters. If Skillz can maintain a high level of revenue growth over the next few years, then your investment will likely do fine from these levels. Vut with so much revenue growth needed for the valuation to make sense, and a history of losses like the $65 million in cash the company has burned through the first six months of this year, Skillz is an incredibly risky investment right now.

Opendoor Technologies

Opendoor is an iBuying platform, which means it buys homes from people and then resells them to others, hopefully making a profit from the spread in purchase prices. In the second quarter, Opendoor’s revenue grew to $1.2 billion, up 59% from Q1 (not year-over-year), driven by a 41% increase in homes sold to 3,481. (The company paused operations during the pandemic so a year-over-year comparison doesn’t make sense.) With low gross margins of 13.4%, Opendoor’s gross profit was only $159 million in Q2.

While these numbers might look OK, there was a metric in the Q2 report that highlights Opendoor’s flawed business model: real estate inventory.

Buying homes is expensive. Last quarter, Opendoor bought 8,494 homes, bringing its inventory balance to an estimated $2.7 billion, up 224% from Q1. The problem with this is that, in order to grow into its valuation, Opendoor will likely need to increase the pace at which it buys homes, which will require a lot more capital.

With negative net income, only $1.5 billion in cash, and a negligible $159 million in gross profit in Q2, Opendoor is going to struggle to increase the pace at which it buys homes from its existing operations and balance sheet. That means it will likely need to take on debt or sell stock to grow, which would hurt its earnings per share over the long term.

Plus, looking at its margins, Opendoor stock trades at an egregious valuation. With a market cap of $11.62 billion and only $330 million in trailing-12-month gross profit, Opendoor is going to have to greatly increase the number of homes it sells to make this valuation work. But remember, if Opendoor wants to grow its home sales, it needs to buy a lot more, which it can’t do without raising funds from third parties. This is not a recipe for building long-term shareholder value and is why investors should stay away from Opendoor right now. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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