These 2 Stocks Carry a Lot of Risk, but Their Upside Is Huge

Most of the stocks in my portfolio are large, established companies with steady cash flow and little reason for me to worry about them executing their growth strategies. But with a small portion of my investable assets, I own some stocks that would definitely fall into the “speculative” category. Here are two in particular that have a lot of risk, but massive reward potential as well if their leadership teams can execute on their visions.

The next big social media stock?

Many people think of Nextdoor (KIND -3.30%) as a place you go to watch your neighbors complain about one another, but it’s actually a pretty impressive social media company. Nextdoor went public as part of the special purpose acquisition company (SPAC) boom a couple of years ago but is now trading for a much more reasonable discount of about 80% to its initial (inflated) valuation. And with a sub-$700 million market cap, it could be worth a closer look.

For starters, the platform has an impressive reach. Nextdoor has 41.6 million weekly active users, which is 13% higher than a year ago (better growth than most larger social media peers). And while the advertising business has been challenging lately, Nextdoor managed to increase its revenue by 4% in the most recent quarter.

The biggest negative is that Nextdoor is still in the relatively early stage of monetizing its users. For context, Pinterest, which has more than twice the number of active users in the United States plus many more overseas, generated $6.46 in revenue per U.S. user in the most recent quarter, while Nextdoor managed about $1.37. And as a result, the business is losing money. In the second quarter, Nextdoor posted an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) loss of $18.6 million. To be sure, with about $550 million in cash and equivalents, there’s plenty of runway to figure out growth. But the question is whether a path to profitability will materialize before Nextdoor burns through another several hundred million dollars. If the answer is yes, this could end up being a massive winner at the current valuation. After all, excluding cash, Nextdoor’s business is valued at about $150 million.

A real estate disruptor in transition

Redfin (RDFN 1.93%) has suffered some big missteps in recent years. Its RedfinNow iBuying business, which has since been shut down, was a massive money loser. It acquired a mortgage company at the height of the low-interest-fueled real estate boom. And there’s a very solid case to be made that it overpaid for its acquisition of RentPath (now known as Rent), for which Redfin paid more than its current market cap.

However, management has done a good job of leading the company’s transition to a focus on its core competencies — real estate brokerage, adjacent services, and its technology platform.

The current state of the real estate market (it’s essentially at a standstill) is making it difficult for Redfin to achieve profitability no matter how lean and focused the business gets. But considering the challenging environment, recent progress has been impressive. For example, although Redfin’s second-quarter revenue declined by 21% year over year, the company’s net loss was roughly one-third of what it was a year ago and the business is expected to generate positive adjusted EBITDA over the next four quarters.

The bottom line is that if Redfin can make it through the tough times and continue to build its online and mobile presence and grow its market share, it could be a big winner. But that’s a big “if” at this point.

Not for the faint of heart

If you’ve been to an amusement park lately, you may have noticed signs before you get on a roller coaster saying things like, “People with a heart condition or high blood pressure shouldn’t ride.”

Well, a similar sign is warranted here. Both Nextdoor and Redfin have massive opportunities, but both need a lot to go right before they’ll be big winners. And even if things go well, they are both likely to be highly turbulent stocks for the foreseeable future. Just look at Redfin: It started this year at about $4 per share, rose as high as $17, and is now trading for less than $5. And this is the volatility in a year when the business is generally doing what management said it would.

I own both of these stocks, but both are rather small positions (less than 1% of my portfolio combined). With companies like these, limiting your position size is a smart idea. After all, if these companies do what I think they’re capable of, a little will be enough. And if they don’t, a small position won’t be a significant loss in your portfolio.

Matthew Frankel, CFP® has positions in Nextdoor, Pinterest, and Redfin. The Motley Fool has positions in and recommends Nextdoor, Pinterest, and Redfin. The Motley Fool recommends the following options: short November 2023 $12 calls on Redfin. The Motley Fool has a disclosure policy.

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