This article is excerpted from Tom Yeung’s Moonshot Investor newsletter. To make sure you don’t miss any of Tom’s potential 100x picks, subscribe to his mailing list here.
Bed, bath and beyond help?
In March, I was wondering if Bed, bath and beyond (NASDAQ:BBBY) was beyond help. GameStop (NYSE:EMG) activist investor Ryan Cohen had just bought a stake, sending shares up 40%. But could the master of meme stocks work his magic on another dying retailer?
Two months later, BBBY popped up on my stock screen again as a potential turnaround. And again I refused to add it to the “buy” list, choosing Crowd (NASDAQ:CRWD) and ZScalerName (NASDAQ:SZ) In place.
Here’s where the actions posted in this article stand today:
- Crowd. 13% (purchase)
- ZScaler. 9% (purchase)
- Etsy (NASDAQ:ETSY). -4%
- Twilio (NYSE:TWLO). -11%
- Bed, bath and beyond. -42%
The hesitation over BBBY has since paid off. The home goods retailer reported dire first-quarter results and fired CEO Mark Tritton. The shares fell again, bringing its total loss to 42% since my last recommendation.
The saga highlights the importance of common sense in buying stocks and crypto. No matter how good an algorithm is, it’s often blind to the megatrends shaping our world.
Today, I’m going to introduce you to a new stock highlighting this fact. And while the company is a potential 5x winner, perhaps only the most patient, risk-seeking investors will buy.
The only stock that defies common sense
The success of investments like CrowdStrike and Zscaler highlights a simple fact:
When it comes to stock picking, megatrends matter.
These are the patterns that emerge over months…years…even decades. Software companies like Google (NASDAQ:GOOGNASDAQ:GOOGL) and from Amazon (NASDAQ:AMZN) web services only became possible as the Internet matured. And hundreds of biotech companies owe their existence to advances in genetic engineering over the past decade.
Nowhere is this clearer than in financials, a sector we covered in depth last week.
In 2010, the Dodd-Frank Act ushered in a sea change in regulation. Banks suddenly found themselves unable to take on excessive leverage, which made it more difficult to earn high returns on equity.
Meanwhile, fintech companies have forged ahead. In 2018, rocket mortgage (NYSE:RKT) exceeded Wells Fargo (NYSE:WFC) as the largest mortgage originator in the United States. And as I noted earlier this week, Charles Schwab (NYSE:SCHW) now derives more income from bank-like lending than from its core business, one of the main reasons why SCHW shares form the core Benefit & Protection listing.
But not all fintechs have become champions. Robin Hood (NASDAQ:HOOD) has lost three-quarters of its market value since its IPO. And even Rocket Mortgage fell 70% as its refinance business dried up.
Picking fintech winners takes some skill…and a lot of luck. And in one particular case, low valuations suddenly tipped the balance in favor of investors.
A beat stock with 5X potential
SoFi (NASDAQ:SOFI) is a comprehensive financial services company targeting young, high-income individuals. The company follows a strategy similar to that Bank of the First Republic (NYSE:FRC) launched in the 1990s. High earners are less likely to default on their debts than credit scores suggest, so any company that caters to them can use a different set of underwriting standards without sacrificing quality.
SoFi is extending credit to those who would not normally qualify. A top computer science grad earning $150,000 right out of school may have no credit history. But in the eyes of SoFi underwriters, it’s more important to consider a borrower’s potential rather than just focusing on FICO scores like traditional banks.
This idea launched SoFi into the world of finance. In 2021, the company generated $732 million in non-interest revenue, making it the 27th largest bank in the United States by this metric. And the downward march in share prices now values the company at 1x the book price, making it the only 72% growing bank to receive such an award.
This makes SoFi a coil spring waiting to fire. The analysts of the morning star estimates SoFi’s fair value to be 3x the book price, up 200% from current levels.
If SoFi succeeds, the shares are worth much more. Value stocks at 4x P/BV like the auto lender Credit acceptance (NASDAQ:CCCC) gives a 300% advantage. InvestorPlace Luke Lango sees even greater potential for 20x returns over the next decade.
The downside of risk taking
All is not well with SoFi’s stock. The company barely ranks in the top 100 of the 382 financial stocks in the Russell 3000 according to the quant-based Benefit & Protection system.
- Growth: A-
- Value: B+
- Quality: B+
- Momentum: A+
- Overall: A-
This would normally disqualify him from consideration. And from a qualitative point of view, SoFi’s current business model is also fragile. In 2021, student loans accounted for one-third of the company’s total origination volume, while home loans accounted for another 24%.
Both industries are highly competitive and struggling to survive. In April, SoFi shares fell 7% after the Biden administration extended a moratorium on federal student loan repayments. The fintech company has since cut its adjusted earnings forecast from $180 million to $100 million.
Rising mortgage rates now create an even bigger headache. Last month, rival Rocket Mortgage reported first-quarter loan originations cratered 48% from a year earlier.
The pain will get worse.
“It’s very possible that we’ll see mortgage rates heading towards 7% or higher, reflecting the inflationary environment of the 1980s,” notes Robert Heck of online mortgage broker Morty. “We’re not close to being there yet, but it’s not impossible either and the inflation data will drive the market over the summer and the rest of the year.”
These obstacles will weigh on the ambitions of SoFi’s management in the medium term. Slowing growth and falling profits are already undermining investor confidence and driving up the company’s cost of capital at the worst possible time. Any reduction in the company’s marketing budget will immediately result in less cross-selling.
“While we expect the number of multi-product customers to grow, this process will take time and will likely require additional rewards and incentive spending,” notes Michael Miller of the morning star. “Until SoFi can establish these intertwined relationships with its customers, there is little to retain them with the company beyond price and reward spend.”
Even though SoFi has built a similar target audience to First Republic, investors should remember that loan club (NYSE:CL) also tried the same strategy with disappointing results.
Is SoFi worth an investment?
Investing in SoFi is a bit like betting on a coin flip or a game of red-black roulette.
On the one hand, SoFi could become a fintech success story. The firm already offers brokerage, insurance, estate and financial planning, auto credit, credit card services, etc., directly or in partnership.
This makes SoFi the only integrated full-service financial company online. Building a banking juggernaut is now just a matter of execution.
On the other hand, SoFi’s management seems to continually be drawn to low-margin businesses to show revenue growth. Student debt, credit card consolidation and mortgage refinancing have historically been deadweight activities in the banking world.
Until SoFi shows it can become a full-service bank, it stays off Profit & Protection’s main buy list. Rising rates could send equities down another 20% from current levels. But because SoFi also has such high return potential, it remains on the newsletter’s watchlist for when success begins to kick in.
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As of the date of publication, Tom Yeung had (neither directly nor indirectly) any position in the securities mentioned in this article.
Tom Yeung, CFA, is a Registered Investment Advisor on a mission to simplify the world of investing.