What happened
Shares of Riskified (RSKD 0.20%) cratered 50.9% in November, according to data provided by S&P Global Market Intelligence. Most of this plunge came after the company reported earnings results for the third quarter of 2021.
So what
Riskified's customers are e-commerce companies, and they use its software to increase sales while decreasing fraud. In the third quarter, revenue grew 26% year over year to $52.5 million, which was ahead of many analysts' expectations. Moreover, the company raised its full-year revenue guidance from $225.4 million on the high end to a range of $226.2 million to $227.2 million.
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Following the third-quarter report, the few Wall Street analysts covering Riskified stock lowered their expectations. Specifically, both Piper Sandler analyst Brent Bracelin and Credit Suisse analyst Timothy Chiodo slashed their price targets, according to The Fly, citing concerns with Riskified's gross profit margin.
Investors shouldn't consider a single metric in isolation when evaluating a company. But in Riskified's case, Bracelin's and Chiodo's concerns about gross margin are well taken. The company touts the ability of its software to cut down on fraud. And it's so confident in its capabilities that it offers its customers a guarantee: When fraudulent transactions sneak through, Riskified pays for it.
When it pays for a mistake, it counts against its cost of revenue. Therefore, gross margin is a good proxy for evaluating the effectiveness of its software. In the third quarter, Riskified's gross margin fell to 46.2% from 52.8% last year. Improvements to Riskified's gross margin are a central part of this investing thesis. So when that metric got worse, it caused investors to abandon the stock in droves in November.
RSKD data by YCharts.
Now what
Management offered this explanation for the disappointment with its gross margins: The company has entered into new e-commerce categories, and its software is still trying to learn how to identify fraud in those categories.
If you already own shares of Riskified, like I do, November wasn't a fun month. But consider that this company only went public in July. I believe it's far too early to abandon ship. Management's explanation about gross margin is reasonable. And considering how small the company still is, it's natural to see bigger swings in operating results from quarter to quarter. In short, one quarter isn't enough to declare a thesis broken, and there's still plenty of time to turn this around.
Over the long term, growth in e-commerce is still a huge tailwind for Riskified. According to eMarketer, e-commerce sales in the U.S. are expected to roughly double by 2025, and the global market is valued in the trillions of dollars. This puts Riskified's market share at a little more than 1%, leaving plenty of opportunity to grow. And the company is well capitalized to pursue this growth. It has well over $500 million in cash and a market capitalization of just $1.4 billion.
These factors could make Riskified stock a lower-risk and high-reward opportunity.
