The debate around retail versus institutional investors and/or algorithm trading has been a highly contested one.
Traders, like myself and Rev Shark, believe we're seeing far more retail participation.
Other stats show there's been little change of ownership on that level in the S&P 500, its underlying names, and similar major indices.
Therein lies the rub. Those folks are looking in the wrong place.
The retail masses, especially those on Robinhood and Webull.com (yeah, there's another site you need to know about), aren't trading the big names. They are focused on small ones. As I've gotten more involved in some areas of research, teaching, and observing these traders, most of the time the underlying stocks are utter pieces of garbage. Traders buy a story and a dream.
The story simply needs to be one that aligns with whatever is hot. The biggest issue I see is many new traders confusing a story with an actual underlying business.
The chase is on in penny stocks that have some potential relationship with something that could do well in the market. And like I've said before, I'll trade squirrel droppings if I think I can make money from it, but rest assured I understand it is squirrel droppings and I'm not deluding myself into thinking it could be something much larger.
The most recent run came in online education. There are real companies in that space. Valuation may be a different story, but a company such as K12 Inc. (LRN) has a billion dollars in sales, cash on the books, a small amount of debt, and it is profitable. 2U, Inc. (TWOU) had a rough go of it last year, but the company does hold working relationships with dozens of the top universities in the United States for online programs. It still has some hurdles to reach profitability, but the underlying potential is very real.
Chegg (CHGG) is another name maybe a bit ahead of itself on valuation, but a solid business working toward profitability with strong growth numbers. Debt could use addressing (hint: great time for a secondary offering to pay off your debt).
But then we got into the next tier domestically. Names that have an online product or software or maybe a new working agreement, but watched their market caps double, triple, or rise five-fold because of the online story. The problem is these are all money-losing names with either very little income or a lot of income but no margins.
Barnes & Noble Education (BNED) became a popular choice despite turning in a terrible quarter recently. One where management talked of the huge negative impact of Covid-19, not a net positive impact. Yes, BNED draws income from online education and digital textbooks and that saw growth, but it is the smallest part of its business. The company wants and needs universities open given its tie-in to bookstores on campuses. BNED's online offerings currently aren't enough to offset the loss of in-person sales.
Boxlight Corp. (BOXL) was another particularly hot name. Now, the company did get some press with Samsung, so I can understand some of the move higher. Boxlight also announced in June an online offering. While that offers potential in the future, a new product in June, MimioConnect, is unlikely to find a ton of use in the fall of 2020. There simply is not enough time for integration and understanding by educators, at least not on a wide scale.
The cloud-based platform looks intriguing and has all the right buzzwords, but the bulk of Boxlight's revenue, and it's not all that bulky, comes from interactive programs and products. In short, in-classroom products like interactive flat panel displays and STEM equipment. If schools don't open, investors can't expect much in the way of revenue let alone growth.
What this adds up to is if you don't catch the big move higher, then chasing will carry huge risks in the smaller names because the underlying business might not be there to bail you out. If you mistake an online-focused company with a company that has an online product but an in-class focus on revenue, there's nothing there to bail you out but hope -- hope for another round of rumors or squirrel traders come along to bail you out.
Honestly, it's sad to see because I realize how many bag holders will be created. Also, I see traders going all-in, literally 100%, in these small names in hopes of striking it big, then repeating the process with the next name.
Long story short: If you are going to trade microcaps or junk names, you probably don't have to worry about the fundamentals if your plan is to hold them for a few hours or even a few days. But if you find yourself "loving" the story and thinking your stock is going to be the next ten-bagger, take the time to actually read the financials and understand what the company does.
Tim Collins provides options trade ideas each day on Real Money Pro, our sister site for active traders. Click here to learn more and get great columns, commentary and trade ideas from Tim Collins, Mark Sebastian, Paul Price, Doug Kass, and others.
