Cathie Wood might be best known for her bullish stands on Tesla or Palantir, but recently the outspoken investor has been quietly building a position in up-and-coming fintech player SoFi Technologies (SOFI -2.54%).
Right now, SoFi is Wood's fourth-largest position across her portfolio of exchange-traded funds (ETF) -- and she isn't the only one on Wall Street who remains optimistic. Equity research analyst Dan Dolev of Mizuho recently upgraded his price target on SoFi to $14 per share -- implying upside of 36% from current trading levels as of Oct. 29.
Below, I'm going to dig into SoFi's most recent earnings report and break down why I see several tailwinds that could fuel even further gains for investors.
Another great quarter for SoFi
On the surface, I wouldn't blame you if you find SoFi to be a problematic investment opportunity. The financial services industry is incredibly crowded, and it makes sense that smaller players simply don't have adequate distribution resources to compete with the likes of incumbents such as Wells Fargo, Bank of America, or JPMorgan Chase.
But in recent years, one area of the financial services realm that has truly disrupted legacy banks is bringing commerce online. Companies such as Robinhood Markets, Coinbase Global, and Block have carved out their own unique pockets within the financial services landscape -- dominating areas like crypto investing, small business loans, or even stock trading.
SoFi, for its part, has joined its cohorts above and is emerging as a star in digital banking. Unlike Wells Fargo and other larger banks, SoFi does not have brick-and-mortar locations. Instead, the company offers services such as loans, insurance, banking, and investing all online through its app.
Online banking is becoming increasingly widespread, and SoFi is leading the charge. For the three months ended Sept. 30, SoFi boasted 9.4 million members on its platform -- an increase of 35% year over year. What's even better is that its members use actively more than 13.6 million products. This implies that each SoFi member uses 1.5 products on average -- underscoring the company's ability to cross-sell additional services once a user signs up.
The lucrative opportunity for SoFi is that the company is quietly building a one-stop shop for a host of financial needs, which should drive more efficient unit economics over the long run.
During the third quarter, SoFi's revenue increased 30% year over year to $689 million while generating more than $60 million in net income -- its fourth consecutive quarter of profitability.
Image source: Getty Images.
Why the future looks bright
To me, it's pretty clear that SoFi's approach to building a robust financial services operation is coming to fruition. And while rising revenue and consistent profits have become a staple of SoFi's earnings reports, I think investors should keep in mind that the journey is just beginning.
SoFi's largest source of revenue comes from its suite of lending products. However, the high interest rates of the past few years caused SoFi's lending segment to stagnate.
There are a couple of important things to point out regarding interest rates. First, despite little growth in SoFi's biggest revenue stream the past couple of quarters, the company still managed to generate modest profitability. It was able to do that by generating growth from non-lending products. This development supports the idea that SoFi's user base is becoming increasingly dependent on the platform and using the app for more than just one of their financial needs.
Second, I think the Federal Reserve is going to continue tapering rates after its cut back in September. The 50-basis-point (0.5%) reduction has already rejuvenated SoFi's lending business. During the third quarter, SoFi generated $392 million in revenue from lending -- an increase of 15% year over year.
Should the Fed continue to reduce rates, I think SoFi's lending business will become even more attractive and begin to accelerate. In turn, I think the company is in a position to bolster its profitability and become an even stronger financial enterprise.
Taking a look at SoFi's valuation
As I've written before, assessing SoFi's intrinsic value is pretty challenging at this stage in the company's lifecycle.
I don't find the price-to-book (P/B) ratio typical used to value banks entirely credible because SoFi is much more than a traditional bank. However, despite the company's profitability, its net income is still quite modest and so I also don't think earnings-based metrics are appropriate at this stage.
To me, SoFi is more of a tech-enabled service that is transforming into a ubiquitous platform offering users a variety of different financial services. This is why I think SoFi should be valued using a sum-of-the-parts (SOTP) methodology.
As SoFi's products beyond lending continue growing, the company should begin reporting widening margins and further profit and cash-flow growth. In turn, I think it would be appropriate to value SoFi based on multiples more aligned with technology and software businesses, as opposed to lower multiples generally used in valuing banks.
For these reasons, I agree with Wood's bullish stance and Dolev's expectations for more gains in SoFi stock. I see now as a great time to buy shares and hold for the long run as SoFi enters the early stages of a new growth phase supported by accelerating revenue, profit, and a platform build-out.
