The new year is here, and it’s time for Foolish investors to re-evaluate their risk tolerances and update their watch lists for 2020. But how to define risk? I like renowned investor Charlie Munger’s view: “Using volatility as a measure of risk is nuts. Risk to us is 1) the risk of permanent loss of capital, or 2) the risk of inadequate return.”
Today I’d like to examine Zillow Group (NASDAQ:ZG), Avita Medical (NASDAQ:RCEL), and Baidu (NASDAQ:BIDU). These three companies face risks ranging from business changes to new products to macro concerns. But I think the risk is more than balanced out by promising opportunities.
High-risk, high-reward stocks aren’t right for everyone, but keeping some on your watch list means you may spot opportunity when the business is no longer as risky and a stock begins to take off.
Zillow Group
Over 14 years, Zillow has evolved from an online real estate database selling advertising into a huge business offering tools to real estate agents and brokers; originating mortgages; and now buying properties.
Zillow is taking a big, expensive risk by getting into the purchase of properties. If it works, the company will vault into a new level of market dominance. If it doesn’t work, the company could struggle under the weight of properties it’s stuck with.
The company’s home-buying arm is called Zillow Offers, and it resides in Zillow’s homes division. Homeowners contact Zillow Offers and ask for a bid. Zillow makes an offer, deducting for repairs, closing costs, and other selling expenses. If homeowners accept the offer, they don’t have to deal with showings, negotiations, unexpected costs, and other home-selling hassles.
The only real competition at this point is Redfin, active in about half as many markets as Zillow,, but others are eager to enter the market. Zillow’s edge is its experience leveraging massive amounts of real estate data quickly in order to make smart offers, and the leads harvested from its website.
Zillow Offers is now available in 22 markets, including Los Angeles — the second-largest market in the U.S., with about 2.5 million housing units.
Revenue is growing quickly. In the third quarter of 2019, revenue for Zillow’s Homes segment was $384.6 million, a 55% increase over the second quarter. Comparatively, third-quarter revenue in 2018 was just $11 million.
If Zillow Offers can combine revenue growth and profitability, the risk will be well worth it for investors.
Avita Medical
New medical devices are inherently risky investments as they face entrenched competition and potential liability if the device hurts a patient. But if a company truly builds a better mousetrap, outsize returns are very possible.
Avita Medical is a comparatively small Australian medical device company specializing in regenerating skin to treat burns. Its RECELL device was approved by the U.S. Food and Drug Administration in September 2018 and was officially launched stateside in January 2019.
Conventional treatment for burns is a long, painful process where patches of healthy skin are grafted onto the site of a patient’s burns. The RECELL device takes an entirely different approach that offers significant advantages. The device harvests cells from a patient’s own skin, then prepares them in a solution that is sprayed across a burn site. Skin regenerates wherever the solution is sprayed. Far lower amounts of healthy skin are required for a successful result than traditional skin grafts, and recovery is much faster.
As of today, over half of all burn centers and burn surgeons in the U.S. are trained on the RECELL system, and 56 of the nation’s 132 burn centers have placed orders. First-quarter 2020 sales came in at 4.6 million Australian dollars ($3.2 million), a 60% increase over the previous quarter.
Next steps for Avita include pivotal trials for the pediatric burn market, and pilot studies for the treatment of vitiligo, a condition in which pigment is lost from areas of skin with no clear cause.
Baidu
Chinese businesses can be risky investments, given the trade war, looser regulation, and government involvement. Baidu is further challenged by declining ad sales and profits, and pressure from Alibaba, Tencent, and others in social media and mobile app adoption. But if Baidu’s efforts in artificial intelligence (AI) work out, the current price will seem like a bargain.
Baidu, which runs China’s largest search engine, operates in several other fields as well. Besides owning several app, video, and social media companies, it is also a leading AI company. Baidu’s AI efforts include its autonomous driving platform, Apollo; its Open AI platform, with over 1.5 million developers; and its DuerOS AI voice-assistant device.
The company has struggled as financial results have disappointed over the past year.. Baidu saw its stock price plunge nearly 70% in about a year. The stock hasn’t traded this low since 2013. But the third quarter of 2019 delivered a ray of light as revenue and earnings per share exceeded analyst expectations, though revenue remained essentially flat year over year.
CEO Robin Li sees AI as the source of growth. Regarding third-quarter results, he said: “On Baidu’s new AI businesses, DuerOS voice assistant continues to experience strong momentum with monthly voice queries surpassing 4.2 billion in September, up over 4.5-fold year over year. On Apollo, we are excited about our progress in early stage commercialization of smart transportation with the release of Apollo-powered robotaxi pilot program to the public in Changsha, Hunan, in September.”
Baidu is a well-diversified, financially strong company able to nurture AI efforts, with a massive audience. The company also has a $1 billion share buyback plan in place. The question for investors is: How long until there’s a significant payoff?
