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There's no sugar-coating it: Growth stocks have been the shining stars over value stocks since the Great Recession ended. Although a Bank of America/Merrill Lynch study found that value stocks have outperformed growth stocks over the past 90 years with an average annual gain of 17% versus 12.6%, the low-interest-rate environment over the past eight years has allowed growth stocks access to cheap and bountiful capital to rapidly grow their business.
But just because low interest rates favor growth stocks, it doesn't mean you can throw a dart and land a winner. Some growth stocks are better off avoided in 2017. Here are three such growth stocks that I'd suggest keeping you distance from next year.
One high-profile growth stock that I'd strongly suggest investors leave parked on the sidelines in 2017 is electric vehicle manufacturer Tesla Motors (NASDAQ: TSLA).
This isn't to say Tesla isn't without its positives. Tesla obliterated Wall Street's earnings estimates in its third-quarter report, it wound up paying off about $600 million in debt, and its Model S sedan continues to gain market share. Perhaps most importantly, Tesla's production levels were a record of 25,185 vehicles, a 92% year-over-year increase and a 37% improvement from the sequential second quarter. Yet, in spite of an expected quadrupling in sales between 2015 and 2019, I'd advocate keeping your distance from Tesla because of three major risks.
Tesla Model S. Image source: Tesla Motors.
The first risk involves increasing competition. Just a few years ago, Tesla's Model S was the clear leader in mileage range and luxury. However, other automakers have made a commitment to bringing more efficient EVs to market. We're seeing improved mileage ranges between charges, as well as more power and luxury with BMW, Porsche, and Mercedes-Benz offering new concepts that could reach the market before the end of the decade. While Tesla's market share dominance is likely to continue in the near term, it could begin to be chipped away beyond 2017.
Secondly, I'd be concerned about Tesla's ramp-up in spending which is likely to keep it as a cash-flow negative company for years to come. No one said building a Gigafactory was going to cheap, or that expanding its annual production from 100,000 vehicles to 500,000 vehicles was going to go off without a hitch. But Tesla has also racked up more than $3 billion in debt, even after paying off $600 million. Its debt-to-equity of 118% further confirms the weight on the company's shoulders.
Lastly, the valuation remains something out of a horror film. Tesla commands a $34 billion market cap despite only producing about 100,000 vehicles a year and losing money. Conversely, a company like General Motors (NYSE: GM) produced 9.8 million vehicles in 2015 and made an adjusted profit of more than $5 per share. Personally, Tesla looks like a no-brainer growth stock to avoid in 2017.
Another growth stock that I don't believe has what it takes to excel in 2017 is rare-disease drug developer BioMarin Pharmaceutical (NASDAQ: BMRN).
On the surface, BioMarin has a lot to like for longer-term investors. Its focus on rare-disease drugs means it'll face minimal competition and that it'll probably have excellent pricing power if its therapies are approved by the Food and Drug Administration. BioMarin already has five rare-disease drugs approved by at least one major regulatory agency around the world, and all of its therapies focus on ultra-rare diseases. Between 2015 and 2019, Wall Street is forecasting that BioMarin's sales will essentially double from a reported $890 million to approximately $1.8 billion.
Image source: Getty Images.
However, there are also two drawbacks to BioMarin. To begin with, incoming president Donald Trump in his latest interview with Time suggested that he would lower drug prices in the United States, which is a point he previously stated on the campaign trail. Trump's only policy mention related to drug prices, thus far, was outlined in his seven-point healthcare reform. Within his proposal, Trump opines that consumers should be able to look overseas for their medicines, since similar drugs in overseas markets are typically priced lower than the U.S. It's unclear if Trump's call for lower drug prices will have any traction in Congress, but rare disease drugmakers like BioMarin that have drugs exceeding the $300,000 annual cost barrier are clearly on Trump's radar.
An even more immediate issue could be BioMarin's ongoing losses. To some extent the company's steep full-year losses can be forgiven since it's reinvesting back into its pipeline. Then again, waiting until 2019 to see a full-year profit doesn't seem worthwhile for a company with a $14 billion market cap when you can go out and open a position in a number of rare-disease drugmakers that are already healthfully profitable, such as Alexion Pharmaceuticalsor Shire.
There appear to be far better options in biotech in 2017 than BioMarin Pharmaceutical.
Finally, investors would probably be wise to step away from fashionable growth story Fitbit (NYSE: FIT) as we head into 2017.
Like the growth stocks above, Fitbit does have positives that can be taken away. For example, Fitbit announced in its third-quarter earnings report that new products accounted for an amazing 79% of its quarterly revenue. Furthermore, total revenue increased 23% year over year, 60% of its customers were new, and 20% of its customers reactivated after being inactive for 90 or more days. This would imply strong new traffic to the brand.
Image source: Fitbit.
But I'll also admit that I was wrong advocating that Fitbit could be poised for a rebound back in October. Despite heavily reinvesting in its new products, the launches of those product, and marketing, all Fitbit got out of it was significantly lower margins and a reduced profit forecast. There's no denying that revenue rose 23% in Q3 2016 from Q3 2015, but just 11% of that was an increase in units sold. The remainder was comprised of price increases on its products. This would suggest that interest in Fitbit's products could be ebbing, even with a lot of extra money being spent on innovation and marketing. The company's lowered fourth-quarter guidance could imply a year-over-year decline in units sold, with a higher average selling price of those units leading to growth.
Fitbit will also need to overcome the stigma of wearable technology that it's nothing more than a fad. In other words, can Fitbit get customers to continually upgrade their device in the same fashion that consumers upgrade their smartphones every year or two? Based on the data released during the third quarter, it doesn't look as if Fitbit's products are resonating enough with existing customers yet. That could change, but I wouldn't look for 2017 to be the year we see this ramp up in upgrades.
Though Fitbit is on track to see its sales climb by more than 50% between 2015 and 2019, I'd suggest keeping your distance from this growth stock in 2017.
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Sean Williamsowns shares of Bank of America, but has no material interest in any other companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.
The Motley Fool owns shares of and recommends Fitbit and Tesla Motors. It also recommends BioMarin Pharmaceutical and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.