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‘Concept’ stocks testing capital allocation

Investing 101

A large amount of capital has moved into so called “concept stocks” in recent months, as retail investors seek to capitalise on popular ‘themes’. Before we discuss this phenomenon, we first must define a concept stock.

  • In short, a concept stock is a company like a start-up, that is in its early conceptual stages of product development or service. It’s an early-stage business that is developing a product or service that investors believe may be of substantial value in the future. The business model and product are at the conceptual stage and have not yet been proven. Typically, these types of stocks are speculative; but if proven successful can exhibit high growth and yield big returns. In most cases, they are losing money and rely on a constant flow of capital.

    Concepts stocks are most regularly founded in the smaller-cap end of the market, or the “SCAP” sector in the US. A surge of capital has rushed into the S&P/ASX Small Ordinaries Index, pushing price to earnings to almost 20 times. The return over the past year has been a whopping 52.15%, with materials weighing the heaviest, at 21.18% of the portfolio and Consumer Discretionary at 17.31%. High valuations mean high expectations, right? Yes, but they can also mean big disappointments, too.

    Given that most of these stocks are priced to perfection, when they don’t deliver, their share prices quickly come back to where they started. The stakes right now are particularly steep.

    The stages of company development begin with “seed” or “start-up.” These companies are very early-stage, even pre-revenue, with usually very limited capital. They will need to raise funds to develop this idea or product and will most likely have a tested prototype or service model and have developed a business plan. The company won’t be profitable yet. The next stage is growth. The company successfully raises funding and is in commercial operation with solid traction and existing customers. Recurring revenue is being generated and the company is growing but might not as yet be profitable. Once profitable come the maturity and decline phases.

    And there have been some truly spectacular gains. Afterpay (ASX: APT) is a good example. It was once a concept stock that had first-mover advantage in the Buy Now Pay Later space. It still isn’t profitable but its business idea has proven successful. APT shares have risen from $1.00 per share (IPO price) to $99 (today’s price). That’s a whopping 10,000% share price gain.

    In this article we’ll identify a concept stock that has risen and continues to rise as it seeks to prove its concept is profitable. One such sector is the semiconductor space. Due to the pandemic, increased demand has caused a global chip shortage likely to last through 2021 and even into 2022. The vast majority of semiconductors are manufactured in Taiwan and USA.

    China is the world’s largest consumer of semiconductors but relies heavily on foreign chips with only 5.6% of its consumption being made locally. Experts say China’s chip-making capability is “generations behind” the leading-edge industry in Taiwan. As a consequence, chip prices have soared 60% from start of year, as the demand for electronics skyrocketed.

    Two ASX listed semiconductor stocks that work in the same space are BrainChip (ASX: BRN) and 4DS (ASX: 4DS).

    BrainChip (ASX: BRN) – The company is working on a cutting-edge chip designed to mirror the human brain. The next solution in the semiconductor race can take hundreds of watts of power and required hundreds of milliseconds to process each object. BrainChip believes it has found the answer. “At only 20 watts, the human brain is the most power-efficient thinking machine in existence.” Therefore, BrainChip is using “neuromorphic computing” to develop a semiconductor that will disrupt the semiconductor industry. The company has begun volume manufacturing of its Akida AKD1000 neuromorphic processor chips. Taiwan Semiconductor Manufacturing Company is slated to have them ready for mass production. Units are expected to be available by August 2021.

    4DS – Another Aussie chip maker, although slightly different to semiconductors; the company makes high-grade storage memory. The company has completed testing of its second Non-Platform Lot with positive results. It was a milestone achievement for the company. The stock was admitted to the S&P/ASX All Technology Index (ASX: XTX) on 22 March. 

    Both stocks are good examples of companies that are at the conceptual stage where their products are being tested and developed for mass distribution. Neither is yet profitable. BrainChip’s free cash flow for this year was minus $13.94m and that of 4DS was minus $4.58m. Despite this, BrainChip is up 988% on the year and 4DS is up 243%. As you can see, the market is pricing in high expectations.

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