Ark Invest CEO Cathie Wood has had a difficult year. Her firm's flagship product, the Ark Innovation ETF, has fallen more than 50% from its high. With inflation still running rampant, many investors are worried about the future of the economy. So they have sold out of many (formerly beloved) growth stocks, presumably in favor of less risky assets.
To her credit, Wood has not shied away from her convictions. Better yet, she has maintained her long-term mindset and doubled-down on her belief in innovation, saying that Ark's portfolio is currently in "deep value" territory. Of course, critics will point to her losses in the past year, but the narrative changes if you widen the lens. Since its inception in October 2014, the Ark Innovation ETF is up over 180%, easily beating the 123% return of the broader S&P 500.
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Tesla (TSLA -1.92%) and Block (SQ -2.28%) currently rank as Ark's first- and fourth-largest holdings, respectively, and the firm sees significant upside. Specifically, Ark says Tesla could hit $4,600 per share by 2026, implying 360% upside over the next four years. Likewise, Ark thinks Block will hit $375 per share by 2025, implying 215% upside over the next three years.
Given Wood's track record, let's take a closer look at both stocks.
1. Tesla
Last year, Tesla overcame semiconductor shortages and supply chain disruptions to once again top the auto industry in terms of electric car sales. It captured 14.4% market share, while Chinese automaker BYD ranked second with 9.1% market share. Better yet, Tesla posted an industry-leading operating margin of 14.6% in the third quarter, and that figure rose to 14.7% in the fourth quarter, reinforcing its burgeoning reputation for manufacturing efficiency.
Financially, Tesla delivered another solid performance in 2021. Revenue surged 71% to $53.8 billion and, thanks to improving efficiency, free cash flow skyrocketed 80% to $5 billion. But Tesla (and Cathie Wood) see this as the beginning of a longer story, one in which the company leverages its software and semiconductor expertise to build self-driving cars.
During a recent earnings call, several Tesla executives noted their belief that full self-driving (FSD) software would eventually be the most important source of profitability for the company. Better yet, CEO Elon Musk said he expects to have FSD solved this year, at which point Tesla will launch an autonomous ride-hailing service. Ark thinks that service will account for more than one-third of revenue by 2026 and, thanks to its high-margin nature, more than half of EBITDA. Ark also believes production ramps and innovations like the 4680 battery cell will boost margins on the core electric vehicle business, driving cash flow higher.
Here's the bottom line: Ark believes Tesla will hit $4,600 per share in 2026, but the company also modeled out a bear scenario in which the stock hits $2,900 per share, and a bull scenario in which the stock hits $5,800 per share. Of course, it's easy to dismiss Wood's confidence as pure speculation, and you would be right to say that a lot of guesswork went into those numbers. Tesla is undoubtedly one of the most controversial stocks on the market for that very reason -- many intelligent people cannot fathom its current valuation, while others see the share price rocketing higher in the years ahead. For what it's worth, I have no plans to sell my stake in Tesla, though the $4,600 price target may seem outlandishly optimistic.
2. Block
Block has come a long way since releasing its first card reader. Today the fintech breaks its portfolio into two businesses: Square and Cash App. Through the Square ecosystem sellers can access all of the hardware, software, and services they need to manage a business across physical and digital channels. That disruptive approach differentiates Block from traditional merchant service providers, which typically burden sellers with contracts, fine-print fees, and bundles of disparate products that require significant IT support.
Similarly, the Cash App is designed to disrupt consumer finance. From a single platform, users can deposit, send, spend, and invest money, and they can even file their taxes for free. Better yet, while banks with physical presences pay about $2,500 to acquire each customer, Block pays about $10 to onboard new Cash App users. That means Block can afford to serve customers that traditional banks cannot, which should reinforce the network effects created by the peer-to-peer functionality of the Cash App.
Financially, Block delivered another solid financial performance last year. Gross profit surged 62% to $4.4 billion and free cash flow hit $714 million, up from $35 million in 2020. While the results were impressive across both ecosystems, the Cash App is catching fire. Monthly active users (MAUs) jumped 22% to 44 million, and thanks to increased adoption of products like the Cash Card, gross profit per MAU rose 13% in the fourth quarter.
Looking ahead, Ark believes Cash App MAUs will hit 75 million by 2025, and that user monetization will continue to improve. Ark's price target is also predicated on the idea that Square ecosystem revenue will grow at 19% per year through 2025, which seems entirely plausible -- Square revenue jumped 47% last year.
Here's the bottom line: Much like Ark's price target for Tesla, its valuation model for Block involves a lot of guesswork. While I certainly believe shareholders could see a 215% return over the next three years, Block looks like a solid long-term investment whether that happens or not.
