3 warning signs with high-risk speculative investments

Here are three things you should look for with companies like Resapp Health Ltd (ASX:RAP) and Mustang Resources Ltd (ASX:MUS).

| More on:
a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Many investors have been stung by speculative companies like Resapp Health Ltd (ASX: RAP) and Mustang Resources Ltd (ASX: MUS) in recent times.

These companies, and many more, have experienced devastating share price falls after promised developments in their core 'opportunities' – I hesitate to use the word 'businesses' – failed to eventuate.

Here are three general-purpose warning signs that might help you steer clear of trouble in this area in the future:

  • Be aware that people have different investment goals + strategies to you

For example, short-term traders picking winning trades often use technical charts or momentum strategies, and these are among the most prolific posters on popular stock forums. If you are looking for investments that you can buy and hold for the long term, you need to know that others can have very different strategies to you, and the things that they buy may not be suited to your needs.

Tangential to this, be aware that many people post on forums anonymously, and may have a vested interest in pumping up the share price of certain companies (e.g. because they hold shares in it).

  • If they're not already doing it, don't invest in it

This is the most important rule. If a company has a wondrous product that is truly revolutionary and will change the world, it will still be changing the world in 20 years' time. Just look at Google, Amazon, Cochlear Limited (ASX: COH), CSL Limited (ASX: CSL), and more.

However, many small companies have no sales and are effectively trying to sell a dream, in the hope of raising enough cash to start building the dream. This is not a route to long-term investment success. Instead of normal business risks, investors are also taking on huge, unquantifiable, binary (i.e., only outcomes are success or failure) bets on the product development process.

Generally, the most common outcome is that shareholders overpay, the company's prospects are mediocre, and people get stuck holding shares that are down 75% while the company slowly goes broke and/or tries to start hyping interest in its shares to raise more cash.

Only buy shares in a company if it's already engaged in its activity on a reasonable scale, and has the revenues to show for it.

  • Be extraordinarily wary of hype

Many investors fail to grasp the impact of hype on share prices and their future investment returns. For example, many would balk at the idea of paying $288 per share for CSL Limited (currently $144/share) even though it is widely acknowledged as the highest quality company on the ASX.

It may stun you then to consider that some speculative companies are priced at up to 47x a rough estimate of their fair value.

For example, Getswift Ltd (ASX: GSW) has a fully diluted market capitalisation of around $470 million at today's share price.

It is priced at 470x its annualised sales, which were $0.25 million in the latest quarter. Tech companies are commonly thought expensive at around 10x sales, which is where accounting software company XERO FPO NZX (ASX: XRO) trades at present.

While Getswift is a lot smaller and expected to grow at a faster rate, on a comparable price multiple, Xero would be priced at $1,363 per share. I can tell you with absolute confidence that if you pay $1,363 per share for Xero today, you're on a railroad to nowhere.

While that is not an apples to apples comparison, it is a vivid example of the way that hype can distort reality, especially if there are no sales or profits to measure. If you keep this example in mind, you may be less likely to overpay for promising stories in the future, preserving your hard-earned cash and taking less risk in the process.

Motley Fool contributor Sean O'Neill owns shares of Xero. The Motley Fool Australia owns shares of Xero. 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. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

A white and black robot in the form of a human being stands in front of a green graphic holding a laptop and discussing robotics and automation ASX shares
Technology Shares

Joining the revolution: How I'd invest in ASX AI shares right now

Advances in artificial intelligence (AI) could usher in a new industrial revolution. Here’s how you can invest in it.

Read more »

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »