Why have FinTech stocks suffered? – May 4, 2022

Sending, receiving and borrowing money has undoubtedly never been easier and more efficient in today’s modern world. We stand before many apps and companies that allow us cash flow flexibility without ever having to set foot in a bank. To put it simply, it’s a bright spot of modern technology that has been fully embraced with open arms.

As the digital shift accelerates, these ways of managing money are becoming increasingly popular and becoming a staple of our daily lives. Many small businesses are increasingly using this technology to relieve the headaches of traditional and increasingly outdated payment and lending methods, such as checks and cold hard cash that you can feel in the palm of your hand.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 good, evil also comes. Throughout 2022, several FinTech stocks have fallen significantly to levels that many were unprepared for. The chart below illustrates the year-to-date performance of three such stocks – Upstart Holdings (UPST Free Report), Block (SQ Free Report), and Affirm (AFRM Free Report) – while shuffling the S&P 500 also for a benchmark.

Image source: Zacks Investment Research

It’s no secret that 2022 has been absolutely tough for these companies, as the chart shows. Affirm has witnessed the biggest valuation drop, down nearly 70% since the start of 2022. Upstart and Block haven’t had it quite as bad, but still saw their shares lose 38% and 34% of their value.

The same bearish picture is apparent when extending the time frame over the past year. Affirm and Upstart stocks have been on a wild ride for most of 2021, but in November the stocks began to fall. Block stocks traded in line with the general market for most of 2021, but quickly came to a halt around the same time.

Zacks Investment Research
Image source: Zacks Investment Research

Since then, stocks have been unable to resume a healthy uptrend. Let’s take a look at why these companies underperformed and see if they can find a new way forward.

Macroeconomic issues

Macroeconomic issues, specifically rising borrowing rates, are one of the main drivers behind the sell-offs of these companies. Inflation rose to levels the world had not seen in decades, prompting the Fed to become much more hawkish. Originally referred to as “transitional” inflation, many investors realized it was a rather vague term, although the Fed was adamant about it.

When the Fed raises borrowing rates, it directly affects high-flying technology and growth stocks that have reached unsustainable valuations. The cost of debt becomes much higher, negatively affecting future cash flows. Additionally, these companies typically borrow the most because they are trying to drive future growth and currently don’t have the cash to do so.

Rising rates are becoming a growing concern for FinTech companies and buy now pay later stocks such as UPST, AFRM and SQ. Although the loans these companies provide carry higher interest rates, one might think this is good for investors – higher interest rates equal more cash for the company.

However, rising borrowing rates can increase the likelihood of rising default rates. Additionally, the financing these businesses need for these loans becomes more expensive with the higher rates, further hampering 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 has undoubtedly fueled the economy; consumers spent significantly more and borrowing demand was high due to favorable rates. However, this has come at a high cost, as evidenced by the high inflation figures. A hawkish Fed sent those stocks to the trash in 2022.

To advance

Many of these valuation declines that we’ve seen in these high-flying stocks look very healthy. Over the past two years, it was hard not to see how these companies’ forward price-to-sales ratios and other valuation measures have skyrocketed. Simply put, sales could most likely have been predicted.

To put things in perspective, let’s look at how far these companies’ forward P/S ratios have fallen from their all-time highs. AFRM’s futures price-to-sales ratio fell 86% to 6.5, SQ’s value fell 76% to 3.1 and UPST’s futures price-to-sales ratio fell 87% to 5.1. As we can see, these valuation levels make at least a little more sense.

Now that the music has been cut, many investors may think it’s the end of the road for these companies. However, the actions taken by the Fed were undoubtedly necessary as inflation was spiraling out of control. The overview is essential here; these companies are still innovative spaces that desperately need it. Moving forward in a new economic environment, I believe these stocks can resume healthy and sustainable price action.

Garland K. Long