Shares of innovative fintech businesses can't seem to get off the ground lately. The ARK Fintech Innovation ETF -- down by more than 60% over the past 12 months -- began making a comeback in July and early August, but slid hard again in recent trading sessions.
If you're like many investors, the risky fintech stocks in this ETF still make you a little nervous. But if you would like to invest in a traditional bank that also possesses the explosive growth potential of a risky fintech stock, there's an interesting option that isn't in the ARK Fintech Innovation ETF, and it looks like a screaming buy right now.
You've probably heard of SoFi Technologies (SOFI 0.26%) and its increasingly popular smartphone application. What you may not realize is that this company has a handful of hidden advantages that could make it an exciting and profitable stock to own in the years ahead.
1. SoFi is its own bank
Unlike most challenger banks, SoFi already has a national banking charter. This enables it to offer interest rates on checking and savings account deposits that would probably embarrass your local credit union. But its advantages don't stop there.
Prior to obtaining its charter, SoFi had to jump through hoops held by third parties, and all of those third parties wanted their cut of the action. Now, it can use the capital held in its members' accounts to originate loans in an increasing range of categories. A decade ago, it got started by refinancing student loans; today, it offers personal loans, auto loans, and even mortgages.
The amount of low-interest capital SoFi has to work with and the number of new loans on its books are both growing by leaps and bounds. In the second quarter, the total number of SoFi members rose by 450,000 to 4.3 million, and the number of products they used grew by 702,000 to 6.6 million.
2. SoFi owns its own credit risk evaluation service
Both traditional banks and the newer, smaller challenger banks regularly pay credit rating agencies for access to people's three-digit FICO credit scores -- and while each agency's process for calculating those scores is a little bit different, they are all based on the simple model first developed decades ago by Fair Isaac and Company. Today, though, some intrepid banks gauge the risks of lending to would-be borrowers using more comprehensive, artificial intelligence-powered rating systems from the likes of Upstart.
With over a million lending products generating repayment data on a monthly basis, SoFi's internal risk evaluation algorithms have a lot of data to work with. This allows the company to serve borrowers who might have slipped through the cracks of a traditional credit risk evaluation without using the services of Upstart or any third party.
3. SoFi is a behind-the-scenes giant
If your business wants to make it easy and safe for customers to pay with any type of card in person or over the phone, you're probably already a SoFi customer, even if you don't know it. In 2020, SoFi acquired Galileo, which owns the most popular application programming interface (API) for installing and running payment services and more. Investment brokerages such as Interactive Brokers and Robinhood also rely on the Galileo API. At the end of June, SoFi's technology platform enabled around 117 million accounts, which was 48% more than it was enabling a year earlier.
4. Its losses probably aren't permanent
Over the past year, SoFi has more than tripled the number of members using its relatively new credit card product. Between setting aside loan-loss reserves for that nascent credit card business and spending ambitiously on sales, marketing, general, and administrative expenses, the company was left with a loss of more than $200 million in the first half of 2022.
SOFI SG&A Expense (TTM) data by YCharts
That loss should trouble anyone considering investing in this stock, but they probably aren't permanent. SoFi made big increases in its sales, marketing, general, and administrative spending in the first half of 2021 but it has mostly held those big operating expenses steady over the past year. Despite that, its net revenue has soared. That's a sign of a well-run business.
It's still a little early to predict enormous profits from SoFi, but the key advantages it has over its rivals in the challenger bank niche give it a good chance of staying on top. It's a great stock to buy now, but only as part of a well-diversified portfolio.
