Sending, receiving, and borrowing money has undoubtedly never been easier and more efficient in today’s modern world. We stand before many applications and companies that allow us cash flexibility without ever having to step foot in a bank. To put it simply, it’s a bright spot of modern technology that has been wholly welcomed with open arms.
As the digital shift accelerates, these ways of handling money are only becoming more popular and are transforming into a staple in our everyday lives. Many small businesses are increasingly using this technology to alleviate headaches from the traditional and increasingly outdated payment and lending methods – such as checks and cold hard cash that you can feel in the palm of your hand.
With all the good, the bad comes too. Throughout 2022, several FinTech stocks have significantly come down to levels many were unprepared for. The chart below illustrates the year-to-date performance of three of these stocks – Upstart Holdings UPST, Block SQ, and Affirm AFRM – while mixing the S&P 500 in as well for a benchmark.
Image Source: Zacks Investment Research
It’s no secret that 2022 has been absolutely rough for these companies, as shown in the chart. Affirm has witnessed the most extensive valuation slash, down nearly 70% since just the beginning of 2022. Upstart and Block haven’t had it as rough but have still seen their shares lose 38% and 34% of their value.
The same bearish picture is apparent upon extending the timeframe over the last year. Affirm and Upstart shares went on an insane run throughout the majority of 2021, but in November, shares started freefalling. Block shares traded in line with the general market for most of 2021 but quickly broke off around the same time.
Image Source: Zacks Investment Research
Since then, shares have not been able to pick up a healthy uptrend. Let’s look at why these companies have underperformed and see if they can find a new path heading forward.
One of the main driving forces behind the sell-offs in these companies is macroeconomic issues, more specifically, rising borrowing rates. Inflation has surged to levels the world hasn’t witnessed in decades, causing the Fed to become much more hawkish. Initially labeled as “transitory” inflation, many investors have realized that this is a rather loose term, although the Fed has been adamant about it.
When the Fed raises borrowing rates, it directly affects high-flying tech and growth stocks that have soared to unsustainable valuations. The cost of debt becomes much higher, negatively affecting future cash flows. Additionally, these companies generally borrow the most because they are trying to spur future growth and currently don’t have the cash to do so.
The rate increase becomes increasingly concerning with FinTech companies and buy now pay later stocks such as UPST, AFRM, and SQ. While the loans these companies issue carry higher interest rates, one may think that this is good for investors – higher interest rates equal more cash for the company.
However, increased borrowing rates can heighten the probability of rising default rates. Additionally, the funding these companies need for these loans becomes more expensive with the higher rates, further hindering cash flow and stunting growth.
Coming out of the pandemic, the Fed was forced to stimulate economic growth, which we saw in the form of stimulus checks. This undoubtedly fueled the economy; consumers spent much more, and borrowing demand was high due to favorable rates. However, it came at a steep cost, as seen in the high inflation numbers. A hawkish Fed has sent these stocks down the drain in 2022.
Many of these valuation slashes we’ve witnessed in these high-flying stocks look very healthy. Over the last two years, it was hard to look away from just how high these companies’ forward price-to-sales ratios and other valuation metrics have soared. Simply put, the sell-offs most likely could’ve been foretold.
To put things into perspective, let’s look at how much the forward P/S ratios of these companies have dropped from their all-time-high values. AFRM’s forward price-to-sales ratio has declined 86% to 6.5, SQ’s value has retraced 76% to 3.1, and UPST’s forward price-to-sales ratio has dropped 87% to 5.1. As we can see, these valuation levels at least make a little bit more sense.
Now that the music has been shut off, many investors may think this is the end of the road for these companies. However, the measures taken by the Fed were undoubtedly needed, as inflation was climbing out of control. The big picture is critical here; these companies are still innovating spaces that need it desperately. Moving forward in a new economic environment, I believe that these stocks can pick up healthy, sustainable price action.
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