Investors in SoFi Technologies (SOFI 0.26%) were excited by what they saw in its fourth-quarter 2022 earnings report on Jan. 30, driving the stock price up 12% on the day. The company beat analyst forecasts for revenue and earnings while displaying solid execution in a shaky economy. However, the company has a history of beating analyst estimates on the top and bottom lines since the fourth quarter of 2021, and that did not prevent the company from sinking to a 52-week low of $4.24 on Dec. 28.
This article will examine why investors shunned the stock throughout 2022 despite solid revenue growth and strong overall operating results. It will also discuss why the sentiment toward the stock shifted to positive in 2023.
Why SoFi's stock dropped in 2022
In 2021, a Morgan Stanley analyst called SoFi the "fastest growth story in consumer finance." However, investors are less concerned about the rapid growth in a rising interest rate environment and care more about how much risk the company takes to achieve that growth. So, what does this company do to achieve its growth, and is it risky?
Although SoFi bills itself as a "one-stop shop for your finances," it generates 72% of its revenue and substantially all its profit from its lending business. The problem is that the company originates 96% of its lending business from its student and personal loan segments, which are uncollateralized loans that Wall Street views at the higher end of the risk scale. Regardless of SoFi requiring a minimum credit score of 680, uncollateralized loans are likelier to default in a rising interest rate environment or recession than collateralized loans like car loans. So, despite SoFi's high growth, many investors viewed the company as far too risky to invest in during the rising interest rate environment in 2022, and the stock price dropped like a rock throughout the year.
Why SoFi headed higher after earnings
The Federal Reserve's commentary and actions concerning interest rates largely shape Wall Street's perception of risk and the narratives about which direction the stock market and individual stocks will head.
Much of the commentary after the Federal Reserve raised interest rates seven times in 2022 was that a global recession was in 2023. However, since the Fed has decreased the size of interest rate hikes from 75 basis points at the November Fed meeting in 2022 to 25 basis points at the end of January 2023, the media is heavily promoting a "soft landing," encouraging investors to bet that the Fed can thread the needle and prevent a recession without aggressively raising interest rates further.
Should "soft landing" proponents prove correct and the U.S. economy avoid a recession, the perceived high risk of SoFi's loans will decline as the odds of borrower defaults decrease. As a result, investors will again judge the company more on its revenue and earnings growth potential and worry less about the lower quality of its loans -- which would be excellent for the stock price.
Many SoFi bulls bid the stock up after the earnings release because they now think the worst of the downturn is over, but investors may want to be cautious.
Not out of the woods yet
When foreign exchange investors believe the Fed is hawkish and will aggressively raise interest rates, they tend to bid up the price of the U.S. dollar. Alternatively, when those investors perceive the Fed is dovish and will pause or lower interest rates, they typically send the dollar's price lower.
Foreign exchange investors have believed the U.S. central bank would ease the pace of interest rate hikes since November 2022, and ever since, the dollar's price against other currencies has tumbled. The main problem for those who believe the worst is over is that a falling dollar has the collateral effect of accelerating inflation. Therefore, one should consider the possibility of inflation reigniting, the Fed responding with more aggressive interest rate hikes, and the economy dropping into a recession.
A recession with large job losses would be terrible for SoFi, as people out of work are much more likely to default on loans. Should the U.S. economy go into recession, SoFi would be down to its last line of defense, hoping its artificial intelligence (AI) chose the right people to lend to, helping to limit defaults. But because this would be the first time a recession tested its AI, you would have to be a colossal risk-taker to place bets that a recession scenario would work out favorably for SoFi.
Let's look at valuation.
SOFI Price to Book Value data by YCharts
The banking industry's average price-to-book value is close to 1, and many banks, like Wells Fargo, have a higher-quality loan portfolio than SoFi. Suppose a recession is still possible; shouldn't SoFi be trading at a lower valuation than banks with a better loan portfolio to account for the higher risk?
With that in mind, you should only buy this stock at current prices if you believe the economy can avoid a recession.
