In a credit-based economy, there will always be demand for companies to lend money to other businesses and individuals. With the rise of the internet and smartphones, a lot of start-ups have tried to take on this market and disrupt legacy institutions. One promising entrant that you may have heard of is SoFi Technologies (SOFI 3.69%). The online bank and consumer lender has added customers at a rapid rate, attracting billions of deposits to its platform each quarter.
The problem is, a lot of these new-age financial institutions haven't proven they can generate consistent profits. SoFi is no different. That's why the stock is down 70% from all-time highs after just a few years on the public markets. But are investors wrong to sell off SoFi stock? Let's take a deeper dive and see if it is worth buying the dip on this bank disrupter.
Fast deposit growth, resumption of student loan business
SoFi has knocked it out of the park attracting new customers to its online platform over the past few years. The third quarter of 2023 was more of the same. It hit approximately 7 million customers in Q3, up from 6.24 million in the second quarter and up from 4.74 million a year ago. It now has $15.7 billion in deposits on its balance sheet -- almost all from individuals -- and it added $2.9 billion just in the third quarter.
With a strong marketing push and ultra-high interest rates paid on deposits (currently a 4.6% annual interest rate, according to SoFi's website), SoFi has made a convincing argument for individuals to move their savings to its bank. With a leaner operation and no physical branches, SoFi has lower overhead costs compared to the legacy banks. This gives it more headroom to raise the interest it can pay to customers while still (in theory) generating a profit.
Increasing deposits is the first step in growing a banking operation. With more deposits on the balance sheet, SoFi has a greater capability to make loans with these deposits. Historically, SoFi focused on private student loans and federal student loan refinancing. However, during the pandemic the federal government enacted its famous student loan moratorium, which only resumed in September.
SoFi will likely start to expand its student loan book again, but in the past few years, it has transitioned to making personal loans with its deposits. At the end of last quarter, it had $14 billion in personal loans compared to $5.9 billion in student loans. These loans earn interest for SoFi, its core revenue generator.
Can they prove this business is profitable?
While customer growth and deposits look great, SoFi has always had one glaring issue: It has never generated a profit. Making money is kind of important for a business. It comes down to aggressive interest rates and aggressive marketing for SoFi. In the first nine months of 2023, SoFi generated $1.4 billion in total interest income. However, it had $533 million in interest expenses -- mainly cash paid to depositors -- and $545 million in marketing costs. This aggressive spending is the core reason the company generated a $349 million net loss so far in 2023, a deeper loss than 2022.
If SoFi thinks it is creating value and could be profitable without spending so much to grow, it should prove it. Clearly, with the stock down 70%, investors are tired of the business losing money. It needs to start generating some positive net income for at least a few quarters and then go back to growing for the long term. Otherwise, the stock is likely going to head lower and lower.
Data source: YCharts
The stock looks undervalued, with a catch
At a share price of about $7.80, SoFi trades at only a modest premium to its book value per share of $5.28. Book value per share is the key metric for evaluating the net worth of a bank. With how fast SoFi is gaining depositors and expanding its lending operations, you'd think book value would be growing quickly too. But since the company is losing money every quarter, its book value per share is actually slightly down the company went public. This means management is destroying shareholder value, at least on paper.
Despite this issue, SoFi stock looks cheap if you believe the company can fix these profitability issues. It clearly has a great brand that is attracting millions of new customers each year. If they can just improve the income statement a bit while still gaining depositors, SoFi stock will likely be much higher a few years from now.
