What happened
Shares of Affirm Holdings (AFRM 0.75%) tanked 34.7% in February, according to data from S&P Global Market Intelligence. The buy now, pay later (BNPL) provider put up strong growth numbers in its second-quarter earnings report, but investors were concerned about mounting losses, heavy increases in marketing spending, and a big jump in credit losses.
So what
On Feb. 10, Affirm reported its second-quarter earnings result that covered the three months ending in December. Revenue growth was strong in the period, up 77% to $361 million, handily beating expectations of $329 million going into the announcement. Just seeing that number, you might think Affirm stock jumped in the days following the report. But that is not the case.
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In order to achieve 77% revenue growth, Affirm grew its marketing expense 267% year over year to $143 million and provision for credit losses 320% to $52.6 million. Marketing expenses outpacing revenue indicates that Affirm is having a harder time finding new customers to grow its BNPL business. Provision for credit losses rising faster than revenue shows the company is going to borrowers who are less likely to pay back those short-term loans. Neither trend is good for Affirm's business. Overall, this deterioration led to an operating loss of $196 million in Q2.
On top of this, Affirm stock is likely under pressure because of the turmoil over at Peloton Interactive. The at-home fitness company uses Affirm to help customers finance their purchases, so when the company said demand for its products has dried up, investors likely took it as a sign Affirm's growth will take a hit as well.
Now what
Right now, Affirm Holdings has a market cap of $11.4 billion. Based on its forward revenue guidance of $1.3 billion, the stock trades at a price-to-sales ratio (P/S) of 8.8. This isn't too expensive for a fast-growing company like Affirm.
However, the most important metrics for investors to follow with Affirm are not P/S or revenue growth. In order to be a good investment over the long term, the company will need to right-size its marketing expenses and loan losses and eventually start generating profits and cash flow. It doesn't matter how much revenue you generate when you're hemorrhaging money.
If this doesn't happen, Affirm stock looks incredibly overvalued, even with shares down 60% year to date. This doesn't mean Affirm stock is guaranteed to be a bad investment, but it is a very risky stock to own right now, and there's no reason it cannot fall much further if things don't turn around for the company in the next few years.
