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

Before you invest in a stock, think about the risk you might be taking and size your position accordingly to manage risk.

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Stocks are risky investments. In the worst-case scenario, your investment can go to $0. More uncertainties in a business means investors are taking greater risk. Investors buy positions in risky stocks, which might trade at a discount and have the potential to deliver extraordinary returns.

Here are two stocks that carry a lot of risk, but their upside can be huge.

Open Text stock

Because of the massive Micro Focus acquisition which totaled an enterprise value of about US$6 billion, Open Text (TSX:OTEX) is sitting on elevated levels of debt in a higher interest rate environment. At the end of fiscal 2023, its net leverage ratio sat at 3.5 times. Before the acquisition, the ratio was two times.

As of the end of June, Open Text had US$9.1 billion of outstanding principal debt with a weighted average maturity of 5.7 years. Its weighted average interest rate was 6.6% with 47% of fixed-rate debt. In other words, the tech stock has interest rate risk and is moderately sensitive to changes in interest rates.

By 2024, it needs to repay a revolving credit from which it withdrew US$100 million. Additionally, it has a US$933 million term loan that is maturing in 2025. After that, it has longer-term debt due in 2027 or later.

Open Text has tremendous experience in mergers and acquisitions. However, Micro Focus is its largest acquisition to date. So, there’s increased integration risk, as it will be more complex to integrate the two businesses.

The tech stock is a Canadian Dividend Aristocrat that has increased its dividend for 10 consecutive years with a five-year dividend-growth rate of about 12%. It only raised its dividend by 2.9% this month, though, as management rightly decided to focus on debt reduction, targeting a net leverage ratio of less than three times by the end of fiscal 2025. At writing, it offers a dividend yield of close to 2.6%.

Because of higher risk in the near term, the dividend stock trades at a discount of about 22%, according to the 12-month analyst consensus price target. If things go well, the stock could roughly double over the next three to five years.

Aecon stock

High-risk Aecon (TSX:ARE) stock is still about 50% below its peak in 2021. The stock has been depressed from four large lingering legacy projects that has fixed pricing, which weighed on results in a relatively high inflationary environment. (In other words, it’s getting paid the same amount, but its costs have increased.) Looking past these projects, the stock could potentially recover to the $21 level in three to five years for price gains of about 90%.

In the meantime, Aecon stock offers a high dividend yield of 6.7%. However, the fact that it has maintained the same quarterly dividend for six consecutive quarters indicates the construction company is going through challenges.

Its trailing 12-month payout ratio jumped to 192%. Thankfully, its retained earnings have served as a buffer to protect its dividend. The stock has maintained or increased its dividend every year since 2008. From this track record of dividend payments, it’s probable that management will try to maintain the dividend in these difficult times.

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.

Fool contributor Kay Ng has positions in Open Text. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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