Safety in investing is often in the eye of the beholder, but not all that glitters is gold. Some stocks appear to be safe on the basis of the company's conservative business model or its large scale, only to leave investors exposed to brutal losses when financial results are worse than anticipated.
Avoiding buying these lemons is a key investing skill that's hard to cultivate without making a lot of costly mistakes along the way. Although no stock's safety can truly be guaranteed, there are some with very stable and long-standing businesses, which makes taking a deeper look into each company's financials and prospects crucial. So let's examine two examples of supposedly safe stocks that have actually lost between 50% and 60% of their value over the last five years, and which could easily fall another 50% in the next five years too.
1. Teva Pharmaceutical Industries
As a generic drugmaker, Teva Pharmaceutical Industries (NYSE: TEVA) has the trappings of a safe investment at first glance. Theoretically, demand for generic medications should be relatively consistent, and it's reasonable to believe that ongoing purchases of such drugs would make for a solid base of recurring revenue, which could increase over time.
Growing the top line, which was above $15.8 billion in 2021, "should" be simple, as commercializing copies of already-marketed therapies is substantially less risky than doing the entire drug development process in-house. And with control of a small handful of soon-to-be-launched generic competitors to blockbuster drugs like Humira, which earned its developer AbbVie more than $20.6 billion in 2021, Teva's near-term growth prospects are arguably quite favorable.
Unfortunately, there are a number of complications that derail this investing thesis. First, the company has a troublesome debt load of $21.6 billion that looms very large in comparison to its market cap of only $10.4 billion. Per management, its free cash flow (FCF) will go to paying down debt between now and the end of 2027.
That debt-reduction project has already been five years in the running, thereby starving the business of the capital it needs to grow. And stagnation isn't safe for investors; its trailing-12-month (TTM) revenue shrunk by 30.7% in the same period five years ago.
The next issue is that the company isn't profitable, so continuing to pay down debt will require dipping into its cash holdings, or growing its earnings promptly, which Wall Street analysts don't expect to happen next year on average. As if that weren't enough, Teva will also soon enough be on the hook for its share of a national settlement against opioid drug manufacturers.
Paying out millions or billions to aggrieved parties means it'll have even less money in the bank to work with when it comes to righting the ship, and it's another factor that should tell investors that the stock isn't a safe purchase whatsoever.
2. PetMed Express
PetMed Express (NASDAQ: PETS) is a stock with a safety narrative that's almost as compelling as Teva's. Demand for pet medications should be relatively constant, and so long as the company can profitably procure and deliver those medications to its subscribers every month, the bottom line will only grow.
The company doesn't have any debt, and the fact that the business pays a dividend supports the idea that its cash flows are stable. And pets won't stop needing healthcare anytime soon, which makes management's plan to diversify into providing telehealth for pets seem like a sound strategy.
The problem with this story is that it clashes with PetMed's performance over the last 10 years, which was anything but reliable. Its TTM revenue grew by only 12.7% in the period, reaching $262.3 million, and its TTM net income actually fell by 5.3%. That suggests the business doesn't have any kind of competitive advantage to guard its margins or its market share. Furthermore, its payout ratio is well in excess of 100%, which means that it's disbursing far more of its earnings as dividends than it can do sustainably.
The silver lining is that PetMed isn't in any danger of going bankrupt, so it still has the potential to accelerate its growth via diversification or another method. Nonetheless, there's something about its business model that's failing to drive the consistent, durable growth that investors look for in a safe investment -- and that's sufficient reason to give it a pass for now.
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Alex Carchidi has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
