Riskified (NYSE:RSKD) went public in July 2021 at $21 a share, and the stock price shot up to $40.48 in September. Since then, things have gone poorly, to say the least. General weakness in the tech sector caused the share price to fall through October, then disappointing third-quarter results sparked a cataclysmic sell-off in November. As a result, Riskified stock currently trades 74% below its all-time high.

Of course, volatility should be expected in growth stocks, especially those of the unprofitable persuasion. In fact, some of today's most successful companies have seen their stocks suffer worse sell-offs. For instance, Amazon's share price fell 90% between December 1999 and April 2001. Then again, that happened during a devastating market crash.

So, here's the question: Is Riskified a smart investment right now, or is this fintech company in trouble? Let's take a look.

Person holding credit card and using laptop.

Image source: Getty Images.

The bull case

As e-commerce has become more popular, fraud has become a more pressing problem for merchants. Unfortunately, traditional fraud management solutions are inaccurate more often than you might imagine. In fact, false declines (such as legitimate transactions mistakenly declined) will cost businesses $720 billion by 2022, and losses due to fraud (like illegitimate transactions mistakenly approved) will total $25 billion by 2024.

Riskified attempts to solve that problem. Compared to traditional solutions, its next-generation platform integrates more deeply with merchants' infrastructure, logging data from the front-end e-commerce site, and back-end systems for payments, shipping, and customer relationship management. Riskified then leans on artificial intelligence (AI) to correlate that data -- hundreds of variables per transaction -- with over 1 billion past transactions. In doing so, the company should be able to identify fraud with great precision.

In fact, Riskified can automate the approval or denial of online orders with 99.8% accuracy, according to management. The 10 largest businesses on its platform have seen revenue rise 8% due to fewer false declines, and they've seen fraud-related operating expenses fall by 39% due to fewer incorrect approvals. That value proposition makes Riskified's platform very sticky. In 2020, Riskified kept 98% of its customers, and the average customer spent 17% more.

Last year, that translated into solid financial results. Gross merchandise volume (GMV) reached $63.4 million, up 60%. Revenue climbed 30% to $169.7 million, and the gross margin rose five percentage points to 55%. After tallying all the expenses, Riskified posted a GAAP loss of $0.81 per diluted share, an improvement over its loss of $1.04 per diluted share in 2019.

The bear case

In the first and second quarters of 2021, Riskified's revenue growth actually accelerated to 55% and 47%, respectively. But in the third quarter, the high-flying fintech hit some serious turbulence. GMV growth decelerated to 28%, revenue growth decelerated to 26%, and perhaps most alarming, gross margin fell seven percentage points to 46%. Put another way, gross profit rose just 10%, climbing far more slowly than sales.

As part of Riskified's Chargeback Guarantee, the company compensates merchants for any fraudulent charges that slip past its platform. Those charges represent Riskified's primary cost of revenue, meaning any positive or negative changes directly affect gross profit. In short, the company's falling gross margin indicates that its chargeback fees are rising faster than revenue. Unfortunately, that means Riskified's AI models -- the very core of its business -- may not be working as intended.

Understandably, that scenario has Wall Street worried, and shareholders have unloaded the stock in a hurry. If Riskified's AI models are indeed faulty, the company's financial problems are far from over.

High risk, high reward

Honestly, I'm not too worried about the slowing growth in GMV or revenue. The pandemic supercharged online sales last year, which would make year-over-year comparisons difficult under any circumstances. But when you consider the current macroeconomic environment -- supply chain disruptions, labor shortages, and rising inflation -- it's not surprising to see Riskified take a hit on the top line, too.

However, I am concerned about the falling gross margin. If Riskified can't accurately detect fraud, this fintech company will lose out to larger competitors like PayPal or Mastercard, both of which provide risk management solutions that supplement their core payments businesses.

That being said, one bad quarter doesn't necessarily indicate a systemic problem, and things may improve over time. On the earnings call, management noted that Riskified onboarded several large merchants during the third quarter, many of which operate in industries where Riskified previously had no presence (no data). That could certainly explain the falling gross margin, because high-quality data is the cornerstone of artificial intelligence. In other words, this may be a problem with data volume, not the AI models themselves. Unfortunately, only time will tell.

So is Riskified a smart buy? That depends on your risk tolerance. With a market cap of $1.5 billion, Riskified could deliver 100x returns if things improve, but its business could also implode if things get worse. Personally, I still like this company, but my optimism is more subdued now. So I'll leave you with this advice: If Riskified is the next great growth stock, a little is all you need. And if it's not, a little is all you want. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.