SoFi Technologies (SOFI 3.69%) had investors buzzing with excitement after management released its second 2023 earnings report on July 31. The stock soared nearly 20% as the reported revenue and earnings exceeded analysts' expectations Seeing how well the fintech bank performed this year despite recent financial institution failures and the subsequent extreme volatility among banking stocks is incredible. As of July 31, 2023, the stock was up a whopping 148% for the year. But with such an impressive run over the first half of the year, you might wonder whether it's still a wise investment or if the market is now overvaluing this high-flying fintech bank. Fear not, dear reader, as this article will dive into whether or not the stock is still worth buying.
There are risks to be aware of with SoFi's lending model
SoFi's lending segment works on a gain-on-sale model, which means it creates the loans and then sells them shortly after to large financial institutions, such as bank-holding companies, instead of keeping them on its balance sheet and earning interest.
The disadvantage of this model is the risk of a financial contagion disrupting the gain-on-sale loan market or negatively impacting one of Sofi's large loan purchasers. Financial contagion is when a financial crisis spreads from one market or region to another. It can occur at domestic and international levels and disrupt financial institutions across markets connected by monetary and economic systems.
Suppose there is an unexpected economic shock or crisis in another market. This may cause a considerable decrease in demand and pricing for loans in the U.S., resulting in a reduced fair value of SoFi's loan portfolio and forcing the company to sell the loans for a lower price than their original worth. SoFi's tangible book value, profitability, and stock price may significantly decline if such an event happens.
Financial contagions often catch investors off guard, leaving them with little time to react. Suppose the gain-on-sale loan market does encounter problems. In that case, it may be too late to prevent significant losses once investors hear the news.
There's a lot for growth investors to like
Although the financial industry poses some risks, many investors are attracted to SoFi's remarkable revenue growth and rising profitability. SoFi has maintained its consistent double-digit quarterly-revenue growth in the second quarter, with a 37% increase compared to the same period last year.
SOFI Revenue (Quarterly YoY Growth) data by YCharts.
Additionally, the company recorded an adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) margin of 16% in Q2 compared to 5.7% and 4.7% in Q2 2022 and 2021, respectively. Many early-stage companies use EBITDA to give a clearer view of their operating performance by removing the impact of financing, accounting, and taxation (non-cash expenses). EBITDA is a way for a company to display its potential bottom-line profitability.
Sofi's results show that the company has drastically increased its operational profitability over the last several years. Additionally, management has forecast generally accepted accounting principles (GAAP) net-income profitability in 2023's Q4.
How did SoFi achieve its terrific performance?
You can attribute SoFi's remarkable financial success to its Financial Services Productivity Loop (FSPL) strategy, an approach to financial services that focuses on acquiring new members and cross-selling products while reducing the costs of running its financial services platform.
Critical components of this strategy include:
- Data-driven decision-making: The company uses data to make well-informed decisions about everything from product development to marketing campaigns, allowing SoFi to target its marketing efforts more effectively and to develop products that meet the needs of its customers.
- Personalization: The company provides customers personalized recommendations, tailored educational resources, and personal finance insights to improve the customer experience.
- Technology: SoFi uses technology like artificial intelligence to automate and streamline tasks to reduce the financial platform's operating costs.
- Additional products and services: It reaches new customers and increases customer loyalty by continually offering more products and services. Becoming a bank was part of SoFi's FSPL strategy to provide its customers with a more comprehensive range of products and services.
Those four components enable SoFi to provide its customers with a best-in-class experience.
You can measure the effectiveness of FSPL in several ways. One way is to look at the continued growth of its membership base.
Image source: SoFi Technologies.
Additionally, SoFi uses total product growth to measure the progress of its FSPL strategy. Total products are the number of financial products and services that have been opened or originated through its platform since the company's inception. as of the reporting date. The company uses this metric to track its performance and progress toward becoming a one-stop shop for digital financial services.
Image source: SoFi Technologies.
Lastly, you can monitor SoFi's operating efficiency to measure progress toward its FSPL goals. When a company becomes more efficient, it can produce more while spending the same amount or less, thus decreasing its operating expenses as a percentage of its revenue. The chart below shows that the company has improved efficiency since early 2021.
SOFI Total Operating Expenses (% of Quarterly Revenues) data by YCharts.
If everything is great, why are some analysts cautious about the company?
Investors could be overvaluing the stock
Management once viewed SoFi as an anti-bank, and in past years, when many viewed it as more of a fintech growth company, it could command a higher valuation. However, some have started to consider the company more like a bank.
The risk for SoFi investors is that the stock could drop if more people value it like a bank. The chart below shows that the market values its stock much higher than most other banks on a price-to-book and price-to-sales basis.
SOFI Price to Book Value data by YCharts.
For those who prefer conservative investments, it would be advisable to steer clear of this stock. However, those who are aggressive growth investors may consider holding onto it.
