Fintech company Affirm Holdings (AFRM 3.08%) certainly has a lot of traits that should make for a great investment. Buy now, pay later (BNPL) is a new and flexible credit product winning lots of fans among consumers and merchants alike. Affirm's founder and CEO Max Levchin is also one of the founders of the company that eventually became PayPal, so it has seasoned leadership in the lending technology industry. And it's a small, fast-growing upstart. With an enterprise value of just over $7 billion as of this writing, Affirm could one day be a huge player in the financial services space.
But after just a year and a half as a publicly traded company, Affirm's stock has seen a hefty decline. Shares are down 87% from all-time highs reached in late 2021. Granted, Affirm was way overpriced at peak BNPL hype last year. But after its big tumble, is Affirm stock a buy now?
Is the BNPL hype fully deflated?
BNPL was a hot product, and an even hotter investment trend, just a year ago. Complete with an app-based marketplace shoppers could peruse, BNPL apps provide easy-to-obtain credit designed to offer consumers flexible payments for larger purchases. It combines elements of traditional merchant lending practices with e-commerce and digital payments technology.
Tens of millions of consumers and merchants around the world are using a BNPL offering these days, and despite macroeconomic issues like inflation putting strain on consumers, BNPL is still growing in usage. Some estimates posit that global BNPL revenue could grow an average of 26% per year through the end of this decade. With that kind of hype, no wonder some investors were blindly piling into stocks like Affirm last year.
Data by YCharts.
Affirm has a number of ways it makes money -- earning a fee for facilitating a sale for a merchant, earning interest on consumer loans, earning a fee when money is transferred over a digital payments network, and providing loan services for third-party investors. It's a transactional business that ultimately relies on consumers making increasing use of BNPL and other credit over time.
So far, so good for Affirm. Q1 2022 revenue was up 54% year over year to $355 million. And though it has an exclusive agreement with e-commerce software giant Shopify providing flex-pay options for the company's Shop Pay Installments product, Affirm is still free to pursue other business agreements for its payment app. For example, Amazon's 2022 Prime Day shopping event featured a deal where Affirm users would earn a $25 credit if they spent $100 on Prime Day and funded the purchase with Affirm. Suffice to say Affirm probably picked up some new users and funded plenty of retail therapy treatments this July.
Transactional businesses can still grow fast, but have unique risks
Affirm and other BNPL apps (Block's Afterpay, PayPal's Pay-In-Four, Klarna, a new offering from Apple, etc.) face ample competition, and that's not likely to change. There aren't particularly high barriers to entry, given that digital payments and e-commerce software technology is quite common these days. In fact, companies like Marqeta offer a software-based "credit card" as an API, allowing a developer to drop financial credit into an app with a few simple clicks.
And for a company like Affirm, there are additional risks as well. A service that relies on consumer spending is transactional and will be cyclical based on retail spending health. Though it's a fast-growing company, it currently trades for less than five times trailing-12-month revenue. Affirm also doesn't generate consistent free cash flow yet, and still reports steep unadjusted net losses. Given its transactional nature, this stock deserves to trade for a lower price-to-sales ratio than a fast-growing software company that relies on sticky and recurring subscription sales.
But could it one day be highly profitable? It sure could. App-based digital payments leader PayPal generates free cash flow profit margins of 20% in a good year. And in its pursuit of greater scale, Affirm had $2.26 billion in unrestricted cash and short-term investments on its balance sheet as of the end of March 2022, offset by total debt of $4.01 billion. It isn't the cleanest balance sheet, but the company has ample liquidity available to fund its expansion efforts.
Is Affirm stock a buy? Only if you're interested in a high-risk, potentially high-reward investment. Here are a few factors to consider:
- Just because the valuation is "cheap" given the long-term potential it doesn't mean the share price can't go lower. If you buy now, expect lots of volatility ahead.
- BNPL is highly competitive, and there could be merger and acquisition activity that affects Affirm's valuation and your resulting investment returns.
- Given these risks, keep any investment in Affirm a small overall percentage of your portfolio -- if you decide to invest at all.
Affirm is a potentially promising stock in the fintech world, but there are plenty of issues that could hold it back from being a worthwhile buy at this juncture. If you decide to buy, consider making it a part of a well-diversified portfolio of other financial service companies and stocks of businesses in other industries as well.
