When your cab driver or local barber is bending your ear about an industry that's a "sure thing," it may be time to pull back on your exposure. A sudden spike in the number of highly aggressive amateur speculators means that a certain sector is becoming more like a casino and it's heading for a losing streak.
By that reasoning, it's probably appropriate that the InterDrone show, dedicated to the booming commercial drone industry, is holding a convention from Sept. 7-9 in the gambling mecca of Las Vegas. (Full disclosure: The author is a speaker at InterDrone.)
More than 4,000 drone buyers, sellers and technicians are thronging the trade show's hallways, buzzing with euphoria about the drone industry's seemingly limitless prospects. The signs of a bubble are unmistakable. Below, we pinpoint a simple and easy way for you to make a quick killing on the irrational exuberance of the drone industry, before the bubble bursts.
When the stock market crested in 1987, 2000 or 2008, were you caught up in the euphoria ... and did you eventually get burned? One of the greatest trading imperatives is to get ahead of the investment crowd. Our suggestion to sell short the FactorShares Trust PureFunds Drone Economy Strategy ETF (IFLY) fits the bill.
Make no mistake: The drone industry is indeed booming. If you choose the right drone stock, you can reap outsized rewards. Generally speaking, much of the optimism over the industry is justified. Drones provide a broad spectrum of benefits to multiple sectors, including agriculture, natural-resource exploitation, defense, shipping, law enforcement, forestry and border patrol, to name just a few.
According to the Association for Unmanned Vehicle Systems International (AUVSI), commercial drones will generate more than 100,000 jobs and have an economic impact of $82 billion from 2015 to 2025. AUVSI reports that there could be 30,000 drones overhead in the U.S. by 2020. Commercial drone use is exploding, and the Pentagon is embracing these pilot-less aircraft as well. Notably, the U.S. Air Force has roughly 70,000 people working to process all of the data and footage that it's collecting from drones.
However, we're now witnessing a boom-bust cycle unfold in the drone industry, whereby a flurry of engineering geeks and ambitious venture capitalists are flocking into the sector. The latest start-ups are desperately seeking seed money, no matter how ill-conceived the business model.
Technological innovation in the drone sector truly is astounding, and these aircraft already are revolutionizing our lives. But the same could be said for many hot biotech and Internet stocks that skyrocketed higher only to crash later. In many industries, especially technology, the cycle of greed and excitement inevitably faces a day of reckoning in which frothy valuations and unrealistic expectations collapse. The drone industry is cresting at the peak of this bell curve; many companies will soon go bankrupt as they slide on the curve's downward slope.
Case in point: the emergence this year of the first exchange-traded fund directly focused on the drone industry. The FactorShares Trust PureFunds Drone Economy Strategy ETF seeks investment results that correspond to the price and yield of the Reality Shares Drone Index. With net assets of $2.6 million, this tiny fund is diversified among the defense (57.82%), commercial (24.22%) and civil (17.93%) sectors. Our recommendation for an easy profit: Sell short shares of this ETF.
FactorShares Trust PureFunds Drone Economy Strategy ETF's expense ratio is 75%, which isn't unreasonable for its class. The fund's top holdings include excellent stocks that we'd be comfortable recommending as individual investments, including aerospace behemoth Boeing, as well as the world's largest commercial drone maker, AeroVironment (AVAV - Get Report) . Among the fund's other holdings, however, are several overvalued or fundamentally weak drone-related stocks that are poised for a fall.
Notably, top IFLY holdings also include wearable camera maker GoPro and small drone maker Parrot. These firms have pioneered compelling technology, and the appeal of their gadgets can't be denied. But they're also companies with vulnerable balance sheets, striving to compete with a growing list of aggressive competitors in an increasingly competitive field.
Consider struggling GoPro, which announced this year that it would introduce its own drone in time for the 2016 holiday season. However, erstwhile Wall Street darling GoPro's stock has fallen 27% year to date.
IFLY opened on March 10 at $25.48 and now trades at about $28; we suggest you short the fund.
If you're looking for sustainable, long-term profits from the drone boom, you should buy stock in AeroVironment, the best play in the industry right now. As of July 30, 2016, the company held a funded backlog of $74.7 million vs. $65.8 million as of April 30, 2016. Shares of AeroVironment now trade at $24.33, but on average, analysts expect shares to rise to $30.50 in the next 12 months. If they're right, the stock will have appreciated 25% in a year.
Another smart drone play is Raytheon, which focuses on military applications. The company dominates the high-margin business of sensors, without which drones can't fly.
Drones are an exciting business with huge investment potential. Much of the enthusiasm is warranted. But don't get carried away and start throwing your money at the flavor of the month. In the meantime, you can profit from the madness of crowds by selling short shares of IFLY.
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