Cathie Wood and ARK Invest have been crushed, particularly by high-growth stocks falling out of favor. However, many of the businesses that Wood and ARK love are still strong, and one of their favorites might be worth buying at this cheaper price.
With Coinbase Global (COIN 0.09%) down roughly 50% from its high, Wood took advantage of this drawdown to buy roughly $7 million of the stock. I (and ARK Invest, too) believe that the business could bounce back and potentially perform well over the next decade. I like its competitive advantages, its cash generation, and its growth opportunities, which is why I have my eye on this Cathie Wood favorite.
The dominance of Coinbase
Coinbase is the biggest exchange in the cryptocurrency industry, in part because it combines privacy with simplicity. Platforms like Gemini or eToro might be secure, but they lack the ease of buying and selling that Coinbase offers, which makes it easy to attract users new to the industry. Robinhood Markets (HOOD 2.56%), on the other hand, has a simple and elegant platform but doesn't have high-quality security for users. Coinbase has both, which is likely why it has attracted 73 million users, who have brought more than $255 billion onto its platform.
This brand reputation as an industry leader has paid dividends for the company. During the rise in popularity of crypto in 2021, it saw major adoption of its services. The number of monthly transacting users in the third quarter grew 252% year over year to 7.4 million, and it showed on the top and bottom lines, along with its cash flows.
In the third quarter last year, it reported revenue of $1.2 billion and net income of $406 million, up 330% and 401%, respectively. The company's free cash flow soared 800% year over year in the first nine months of 2021 to $7.7 billion, driven by $5 billion in custodial fund additions.
Why I haven't jumped in yet
These kinds of growth figures are jaw-dropping, and with the company's competitive advantages, the stock looks like it could soar in line with the rise of the crypto economy.
However, Coinbase's incentive structure is potentially flawed. The company makes money on each transaction, meaning it would make much more from a day trader than from a long-term investor. This could potentially motivate Coinbase to create a platform that encourages day trading rather than a buy-and-hold strategy, presenting a moral quandary for some investors.
Many long-term investors want to invest in a company they think will make the world better, and one could question whether Coinbase is that type of investment. Coinbase would benefit from encouraging day trading, and many investors might face a moral dilemma from supporting this future if Coinbase were to go down this road. To be clear, the company has not shown signs of encouraging this, unlike other trading platforms like Robinhood, but incentives are such that it would benefit if it were to encourage day trading.
Another worry is whether Coinbase can continue this fast growth. Cryptocurrencies like Bitcoin (BTC 0.07%) have been dropping like rocks, and that could result in many investors selling and not reinvesting. If investors leave the market, Coinbase would suffer from less trading activity, and see slowing or even declining growth.
How Coinbase could continue to dominate
A date for the fourth-quarter earnings report has not been set, but that report could provide an important view into Coinbase's ability to retain users and activity in slumping crypto markets. If it can keep its trading volume stable or even increase it compared to the third quarter, Coinbase could show that as the market leader, its earnings are less volatile and that it doesn't rely so much on high cryptocurrency prices.
Toby Lütke, the chief executive officer of e-commerce giant Shopify (SHOP 2.69%), has joined the board of directors, which is great news for Coinbase. Shopify has never been short on innovation, and Lütke has been the main driver of its success. As a Coinbase director, this visionary can help the company succeed in some of its growth endeavors, like its expansion into non-fungible tokens (NFTs).
Coinbase is valued as if its growth will slow immensely. It trades at 18 times earnings and less than five times free cash flow, which are extremely low multiples for a company with so much potential. The bar isn't very high for the company, so if it can maintain its revenue and activity on its platform and continue seeing strong growth, shares could explode after it reports fourth-quarter earnings.
With the strong competitive advantages it has and its recent addition to the board, I could see Coinbase surpassing expectations, which is why I am keeping a very close eye on it this earnings season.