ARK Innovation Was Crushed: Should You Buy The Dip?

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In this edition of the Alpha Letter, we cover: 

  • Stocks & Options: ARK was crushed Thursday - Should you buy the dip?

  • Dividend Investing: How to make money with dividends

  • Undervalued stock pick: Update for subscribers on an idea we are accumulating

Thursday was a tough day for the “Ark basket of stocks”, as SPACs and formerly high-flying tech names were brutalized. Cathie Wood favorite Workhorse Group (WKHS) was down 12% and Fastly (FSLY) lost 27%.

Below is Thursday’s option flow for the Ark Innovation ETF (ARKK), thanks to the Vigtec Options Matrix.

Many are calling on others to buy the dip in Ark names. While a 27% dip may suddenly seem “cheap” for a company like Fastly that was trading 200% higher just three months ago, there is a good reason these stocks are falling so hard.

2020 was a magical year for tech investing. Dozens of tech plays gained several hundred percent even after most believed that the rally couldn’t go on. However, what the market gives, it takes away.

You must be careful to not fall into a common trading fallacy; many traders mistakenly believe that every dip is worth buying and that companies will always return to their previous highs. 

In reality, many of these companies traded at valuations several times their fair value from a fundamental standpoint. There is absolutely no guarantee that they suddenly bounce back up.

Even long-term successful companies can take years to recover from bubbles that give them extremely favorable valuations.

Amazon took a full decade to trade back above its 1999 high. 

Amazon traded at $94 during the peak of the 1999 bubble. It fell back to the $12 to $40 range until about 2010, when it passed the $94 mark again.

So even if you’re buying the dip in a company you’d hold for the long-term, keep in mind that dips can last for years. 2020 was an extremely unusual year and may have given many of us an unrealistic expectation of how quickly the market moves. 

See Amazon’s chart below:

I’ve been growing concerned about how confident many traders are that names like Workhorse and Tesla will very quickly bounce back to their all-time highs. They definitely could, but the rotation out of high-priced tech has been so rapid that it’s hard to quickly gather the momentum to bring prices back to those previous levels.

Maybe ARKK was oversold yesterday and it could bounce back today. If you’re scalping for a quick 2% profit then it’s a good play. But overall these names are all in a downtrend, so you may get stuck holding a bag if you’re expecting a quick recovery. 

Think of all the investors that have already rotated out of tech and into reopening plays. Many of those investors aren’t about to dump all their money into companies that have declined 30% in the last two months.

Several of these Ark plays are down 30% from all-time highs, like Tesla. But after a 30% loss, you actually need a 42% gain to get back to even, not a 30% gain.

If you’re looking for mid-term or short-term plays, we highly recommend not chasing these high-priced, non-profitable companies as they continue to fall. There are plenty of stocks that have momentum right now. Amazon, Wells Fargo, Google, Moderna, and several others all had bullish options flow on Thursday and are in the midst of upswings. 

If you don’t already, we highly recommend looking at the daily option flow using the Options Matrix. It can help determine where and how the money is flowing. 

Here’s a view inside the options flow of Russell 2000 names. GameStop, Plug, and NovaVax all saw very bullish option activity Thursday. 

Dividend Investing

Have you ever considered dividend investing?

Usually it’s considered a value strategy for people closer to or in retirement. But maybe that’s changing in 2021.

The WisdomTree US SmallCap Dividend Fund (DES) is up 22% year-to-date and yields 2.08%. Not bad at all considering where interest rates are at.

Its largest holdings are companies you may not have heard of: Kontoor Brands, Vector Group, and B&G Foods are the top three holdings in the ETF.

Dividend investing is a large part of my long-term investing strategy. In my view, the goal of investing is to eventually accumulate enough money to live off of income investments like dividend stocks, bond funds, and REITs. Right now, dividend ETFs seem to offer the most attractive yields.

Say that you park $1 million into DES right now. You’d earn about $20,000 based on the current yield. 

Not amazing, but for most of us that would cover our basic expenditures.

Here’s where the long-term aspect of dividend investing comes into play. Over the long-run, companies in the ETF will continue to increase their dividend, which increases your effective yield. Thus, if the original dividend increases by 4% per year, the dividend yield at the end of year four would be an effective rate of 2.96%.

We created a crude model of what a $1 million investment could look like below.

Assuming you invest $1 million into a dividend ETF that yields 2% and that yield increases 4% per year, with an annual stock appreciation of 6% per year, your original investment at year ten would be $1.8 million that pays out $53,0000 per year.

But what if your original yield was 3% and it increases at a 5% rate per year and the annual stock price of that investment increases at an 8% rate per year? Here is what happens.

At the end of year ten your original investment would be worth $2.1 million that yields $105,500 per year.

This shows the power of long-term dividend investing and why it is a major portion of my portfolio.

It’s important to keep in mind that a high dividend yield isn’t necessarily a good thing. Yields are calculated based on the most recent dividend paid. So let’s say a company pays a dividend of $1 while it’s trading at $100. Because dividends are paid once per quarter usually, the yield would be 4%. 

Let’s say that a month later, the company gets horrible news and may have to declare bankruptcy. The stock declines to $50, but the dividend yield will still be calculated based on the prior dividend. The yield is now 8%, but that doesn’t account for the fact that the company may have to cut the dividend in the future or stop paying it all together.

The holy grail of dividend investing is a high-yielding dividend that will steadily increase every year. While this is rare, you can either sort through the financials of high-yielding dividends to figure out how safe the dividend is, or you can simply park your money in a high-yield ETF. 

The top 20 dividend yields in the S&P 500:

Update To Alpha Subscribers

Speaking of high dividend yields. We recently provided an update on a stock we are long and continuing to accumulate.

This is a company with a $73 million enterprise value with normalized free cash flow in the $20-25 million range.

The company has net cash of $47 million and will likely reinstate its dividend sometime in 2021.

If the dividend is reinstated at the prior rate the yield would be over 5%.

The best thing about this investment is the market sold off the stock yesterday (by over 8%) because it simply doesn’t understand the story.

Subscribers can view the research report here.

Alpha Thought