Ark Invest, the investment management firm founded by Catherine Wood (Trades, Portfolio), focuses on investing in disruptive technology and manages a plethora of "active ETFs” in this space.
One of its most popular exchange-traded funds is its Ark Fintech Innovation ETF (ARKF, Financial). Banks and legacy financial companies have ruled the financial system for decades. However, in recent years, fintech “disruptors” have been eating market share and growing rapidly.
In this discussion, I will take a closer look at the two largest fintech stocks in the portfolio which Wood has recently been buying heavily.
The largest position in Ark’s Fintech Innovation ETF is Shopify Inc. (SHOP, Financial), which makes up 13.18% of the portfolio. Shopify is an interesting company to find at the top of this list as I would not consider it a pure-play fintech stock by default, but more of an e-commerce company. However, I have a theory why this may be the largest position.
Shopify’s stock price fell off a cliff in November 2021 and was butchered by 78% after reports of slowing growth following the pandemic boom of 2020.
Wood likely saw this decline as an opportunity to purchase the stock at a signficiant discount. Ark increased its overall position in the stock by over 1,000%. At the time, shares traded for an average price of $34, which is slightly below where the stock traded at the time of writing. Therefore, even though Shopify may not be a pure fintech play, Ark Invest’s limited capital (after huge outflows) needs to be deployed into the best opportunities. The company also has a fintech part of the business, which I will get into in the next section.
Shopify’s platform enables small businesses and entrepreneurs to easily create their own e-commerce store. Since its founding in 2006, it has grown to become the second-largest e-commerce company in the U.S. with a 10% market share. This is higher than eBay Inc. (EBAY, Financial), which has a 4.2% market share, but lower than Amazon.com Inc. (AMZN, Financial), which dominates with a 40% market share.
The fintech part of business includes Shopify’s payments system and point of sale solutions for brick-and-mortar retailers. In addition, the company has a loan business called Shopify Capital, which provides credit to the underserved small-medium sized business market.
In recent years, the company has scored major partnerships with Alphabet Inc. (GOOG, Financial) (GOOGL, Financial) for its Google shopping integration. In addition, Shopify has partnered with Tik Tok Shopping in order to enable creators to sell products directly from the fastest-growing social media company in the world.
On Oct. 27, Shopify reported strong financial results for the third quarter of 2022. Revenue of $1.37 billion increased 18% year over year and exceeded analysts' projections by $30.33 million. This growth was driven by strong Merchant Solutions revenue of $990 million, which increased by 26% year over year. This was further driven by strong gross merchandise volume growth and increased penetration of its Shopify Payments and Shopify Capital Products.
Further, Shopify reported last week record Black Friday sales, which increased by 17% year over year.
The company also reported an earnings loss of 12 cents per share, which topped analysts' expectations by 14 cents. On an adjusted basis, the 2-cent loss beat estimates by 5 cents.
Shopify has a strong balance sheet with $4.9 billion in cash and short-term investments. In addition, the business has $917 million in long-term debt.
Shopify trades at a price-sales ratio of 8.8, which is 75% cheaper than its five-year average.
The GF Value Line also indicates a fair value of $190 per share, which means the stock is significantly undervalued at the time of writing based on its historical ratios, past financial performance and analysts' future earnings projections. However, GuruFocus does warn of a possible value trap due to the sharp decline in share price and slowing growth, but I do not feel this is a major issue.
The second-largest position in Ark Invest’s Fintech Innovation ETF is Block Inc. (SQ, Financial). Formerly known as Square, this stock makes up 10.07% of the portfolio weighting with a position value of $73 million.
Wood continued to buy shares of Block in the third quarter of 2022. Shares traded for an average price of $70 each.
Block’s stock has been butchered by 76% from its all-time highs in October 2021, which has been mainly driven by the macroeconomic environment.
Block’s business model consists of two main ecosystems. The first is the Cash App, which is a mobile wallet that enables peer-to-peer payments via a Cashtag ID, in addition to stock trading, bitcoin trading and more. The idea of the ecosystem approach is the more features customers use, the more “sticky” they become with the product, resulting in increased trading volume.
The second ecosystem is its Square point of sale small business payment solution, which also includes Square Capital, an SMB loan provider. Block’s management believes the recently acquired buy now pay later provider, Afterpay, will help bridge the gap between the two ecosystems.
On Nov. 3, Block reported solid financial results for the third quarter of 2022. Revenue of $4.5 billion beat analysts' consensus expectations by $47 million. In addition, it increased 18% year over year.
Block has recently faced major headwinds as the company derived 40% of its revenue from bitcoin trading on its Cash App. As cryptocurrency prices have been butchered, traders have become fearful and the whole market has come to a standstill. The good news for Block is its core business is growing fast. If we exclude bitcoin revenue, its core business revenue was $2.8 billion, which increased by a solid 36% year over year.
In addition, bitcoin trading was never a key profit driver for Block, thus the decline has not immensely affected profits. The company reported gross profit of $1.57 billion, which increased by a blistering 38% year over year.
Block reported an earnings loss of 2 cents per share, which beat analysts' expectations by 24 cents. On a non-GAAP basis, earnings per share of 42 cents topped projections by 19 cents.
The company also has a solid balance sheet with $6.5 billion in cash, cash equivalents and short-term investments. Block does have fairly high debt of $4.5 billion, but only $460 million of this is short-term debt that is due within the next two years.
Block trades at a price-sales ratio of 2, which is 73% cheaper than its five-year average.
The GF Value Line also indicates a fair value of $220 per share, which means the stock is significantly undervalued at the time of writing. Again, GuruFocus indicates a possible value trap, but I do not believe this to be the case.
Both Shopify and Block are poised to benefit from the growth in digital payments. The two companies have had their stock prices decimated, while their fundamentals have continued to perform well. Wood has seen this volatility as an opportunity to purchase the stocks cheaply and, therefore, they could both be great long-term opportunities.