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Why You Might Want to Avoid 'Virus Stocks'

The stocks of companies that have obtained some sort of perceived benefit from the outbreak of the novel coronavirus (Covid-19) have soared over the past couple of months as the rest of the market has tanked. While the S&P 500 is down approximately 17% year to date as of April 6, these so-called "virus stocks" have posted gains that range from reasonable to staggering.

Some of the countries that were hit earliest by the virus, such as South Korea, Singapore and China, appear to show signs of reduced infections and economic recovery. Some attribute this to either under-reporting or strict government-enforced quarantines that most countries would be unable or unwilling to resort to. However, regardless of the multitude of information, misinformation and wild speculation floating around the internet, the world - and its companies - will eventually bounce back from this blow.


When that happens, how will the "virus stocks" fare? In this discussion, we will take a look at three different types of stocks that buyers have flocked to in this crisis and analyze their chances of maintaining their trajectories once the world gets out of quarantine.

Communications and entertainment

Schools, restaurants, office buildings and other non-essential public places around the world have been shut down to slow the spread of the virus. As people are encouraged to stay at home and practice social distancing, stocks related to communications and at-home entertainment have soared.

For example, Zoom Video Communications Inc. (NASDAQ:ZM), a provider of both small-scale and large-scale video conferencing services, is being used by many schools to hold online classes. Though Zoom has waived its subscription fees for educators affected by Covid-19, the stock is still up 23% since markets peaked in late February and 88% year to date. Despite this rise, a high valuation isn't new for Zoom, which has had a price-earnings ratio in the thousands range since its initial public offering in early 2019.

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Video streaming giant Netflix Inc. (NASDAQ:NFLX) originally saw its share price fall with the broader market at the end of February, but shares began trading higher as the company reported an increase in subscribers. Overall, the stock is down 6% since the end of February and has increased 11% year to date. Though its price-earnings ratio is high at 91.99 on April 6, it has been significantly higher over most of the past year.

Without the extra demand from Covid-19, investor optimism for these stocks is likely to wane. At the very least, the short-term traders and speculators will likely want out. Since these companies have historically traded at high valuations, investors who believe in the long-term growth of Netflix could be better off sticking with their investing theses, though with Zoom, the price-earnings ratio of more than 1,000 provides ample room for dramatic volatility swings.

At-home workout gear has also been in slightly higher demand, though most sellers of this gear are retailers that are struggling overall due to reduced outdoor sports activities and brick-and-mortar store closures. One exception is Peloton Interactive Inc. (NASDAQ:PTON), which sells interactive stationary bikes. Its stock is up 6% since the end of February and 1% year to date. With an operating margin of -17.59%, investors may want to wait for the company to be traded for more than a few months to see if it can grab enough market share and become profitable.

Pharmaceuticals

Not all pharma companies have seen their share prices jump - only the ones that have been publicly working on vaccines or treatments for Covid-19. A successful vaccine or treatment would be in high demand, potentially leading to a boost in reputation and funding.

Among the frontrunners in this field, at least among U.S. large-cap publicly traded companies, are Gilead Sciences Inc. (NASDAQ:GILD) and Moderna Inc. (NASDAQ:MRNA).

Gilead has been testing its antiviral drug remdesivir against the virus. The drug was originally developed to combat Ebola, though it was shelved after proving less effective than other options. Results from the first clinical trials of the drug against Covid-19 are expected to be reported sometime in April, though Gilead has already donated 1.5 million doses for compassionate use (enough for 140,000 severely ill patients). Gilead's stock price is up 16% since the end of February and 20% year to date.

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Meanwhile, Moderna has been rushing to create a vaccine for Covid-19, causing its share price to surge 84% since the end of February and 78% year to date. The biotech company's unique technology uses messenger RNA as a platform for vaccine development, which has the potential to facilitate vaccine development in record time. If successful, this would not only boost Moderna's reputation, it would also help to fix a big problem with vaccine development: it's risky and unprofitable for companies, meaning many would rather focus on a cure than a vaccine. "In fact, right now there are only four big pharma companies that are focused on it [vaccines]," MIT Sloan finance professor Andrew Lo said about the topic. "A number of them have left the space, and smaller companies have gone bankrupt or are not developing vaccines anymore."

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Where the stock prices of these companies go in the short-term future will depend largely on the success of their efforts to combat Covid-19. Good news will help, while any bad news, such as side effects or failures in clinical trials, could cause prices to plunge as investor sentiment turns negative.

Essentials

Several companies that provide day-to-day necessities have seen upticks in sales as consumers prepare to stay at home longer and worry about potential shortages. Non-perishable food items such as canned goods and hygiene items such as toilet paper have been in particularly high demand.

Clorox Co. (NYSE:CLX) is one stock that has been on the rise, increasing 7% since the end of February and 15% year to date. With most of its profits coming from bleach, disinfecting wipes and other cleaning products, Clorox has seen its products fly off the shelves as both individuals and companies seek to sterilize their spaces. The company's price-earnings ratio of 28.47 is near a 10-year high.

Most famous for its canned foods, Campbell Soup Co. (NYSE:CPB) has seen its share price increase 3% since the end of February, though the share price is flat year to date. This isn't a hot stock, unlike most of the other companies in this discussion. The company's profits are likely increasing, so investors are holding the stock, and there has been some buying as well. At a price-earnings ratio of 9.98, Campbell could be considered undervalued, though the company has seen its bottom line fall in recent years even as the top line has grown. Overall, like most consumer defensive stocks, this one is not likely to see any dramatic changes related to economic events. Walmart (WMT), which is also flat year to date, also falls into this category.

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Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research or consult registered investment advisors before taking action in the stock market.

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This article first appeared on GuruFocus.