After the Gold Rush: How to Pick a Stock Down 50% From Its Highs [PREMIUM ANALYSIS]

While sell-offs can be an opportunity to buy low, they’re just as often an opportunity to throw good money after bad.

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What if I told you that you could buy a whole town for less than a million bucks? (Can you even get an apartment in Toronto for that?) Well, in Lake City, Colorado, you can. Here’s the catch: Nobody lives there anymore. 

Lake City was once a bustling town. Incorporated in 1873, it became a hub for trade as people arrived from across the continent to seek fortune in the Colorado mining boom. Although there were successful mines in the area – the Golden Fleece mine produced $1.4 million in ore — and it became a railroad hub, the town began to fade in the early 1900s. Mining and speculation continued throughout the 20th century, but no significant finds materialized. In the end, Lake City had been built by men speculating on mineral wealth not yet discovered rather than a truly great find. When the boom ended, Lake City dried up.

Mark Twain once said, “A mine is a hole in the ground with a liar on top.” Some companies aren’t all that different. In mining and in the stock market, investors are willing to pay up for prospects that have yet to produce meaningful (sometimes any) results, driven by hope, greed, and the madness of crowds. That hope can generate lots of speculative activity, but over the long term, a hole in the ground will be valued for what it is. Even then, some investors will keep throwing good money after bad, continuing to tell themselves a story that just isn’t true.  

Today, we find ourselves at the back end of an investing gold rush. The legion of r/WallStreetBets posters have returned to normal life. Many investors are probably wondering whether they’re holding a company poised to bounce back or a proverbial hole in the ground. Here are 3 things to ask yourself to help answer that question: 

Is There Anything Coming Out?

Money talks louder than words. What a business is doing is much more important than what it’s going to do

Plug Power (NASDAQ: PLUG) has been a couple steps away from deploying hydrogen fuel cells at scale for 25 years. In fact, the stock is up 7X over the past 5 years. However, the company has never produced a single dollar of profit or cash from operations in its history. That’s why shares are down 87% since the IPO. It cannot fund its operation without selling shares. Nevertheless, shareholders continue to pour money into the proverbial ground year after year, waiting for something to come out. 

Compare this with a company like Amazon (NASDAQ: AMZN), which went public around the same time as Plug. For years, commentators lambasted Amazon for how little profit the company produced. However, the business has been cash-flow-positive for more than 20 years and has become an essential part of over 300 million customers’ lives. Rather than selling stock to fund the business, Amazon’s management repurchased $6 billion in stock last year. 

The stocks of both Amazon and Plug Power have been washed out in the recent market swoon. However, only one of these companies is sending anything out of its metaphorical mine, and only one of them is worth considering investing in today.  

Who Am I Doing Business With? 

Once again, actions speak louder than words. When management is aligned with shareholders, both in terms of ownership and compensation, you’re much less likely to be doing business with a bad actor. 

Plug Power’s management owns less than 1% of the company’s stock. Meanwhile, Bezos alone holds more than $90 billion in Amazon stock. Moreover, Plug has, in the past 2 years, needed to restate past financial statements. 

Which kind of management team do you trust more?

Is It Important?

To answer this question, Motley Fool co-founder David Gardner uses what he calls “The Snap Test.” If, like the Marvel Comics supervillain Thanos, tomorrow morning we snapped our fingers and made a company disappear, would the world notice? 

The world didn’t notice when Lake City went belly up, but we’d sure hear about it if Amazon disappeared. If it’s hard to imagine a world without your company in it, there’s a solid chance it’s a good business, not just a good story. 

The Foolish Bottom Line

“Buy low, sell high” is an investing axiom. While sell-offs can be an opportunity to buy low, they’re just as often an opportunity to throw good money after bad. With a little bit of analysis, though, we can sift through the wreckage to find hidden gems left behind after the gold rush. 

(Looking for some help with that? Check out our flagship offering Stock Advisor Canada, where we do the sifting for you, surfacing one U.S. and one Canadian idea each month. Our average selection has outperformed the TSX by more than 10 percentage points since we got started nearly a decade ago, and we think there are even more gains to come.)

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool recommends The Motley Fool has a disclosure policy.

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