Affirm: Time To Go Long (NASDAQ:AFRM)

Investment Thesis

Affirm (NASDAQ:AFRM) is a stock that is highly shorted for good reason. Because it has a highly controversial business model that describes itself as “no fees, no gotchas, no surprises”, it’s very much fee driven, with nearly 60% of its products being fee-driven.

And its financials reporting is questionable. However, the fact remains that ARK-like (ARKK) stocks, which were the first to sell off in the current bear market, appear to have stopped selling off and found a bottom after many of them crumbled more than 60%-70%.

Hence, I’m inclined to upgrade Affirm from neutral to a tepid buy rating. Here’s why:

What’s Happened to This Market?

In the last few days, we’ve seen two noteworthy results that have really changed the dynamic of this market. We saw PayPal (PYPL) and SoFi (SOFI) report results that the market welcomed strongly. Incidentally, I’m bullish on PayPal. And neutral on SoFi.

What’s more, if we cast our minds back to February 2021, when the ARK-like stocks hit the top of the bubble, the very first companies to get utterly hit to a pulp were the frothy tech companies.

And as you know, countless companies are now down more than 60%-70% from their highs, with some, like Upstart (UPST) getting annihilated and falling close to 95% at one point.

Now, there’s really no question that in 2020 and 2021 stocks were incredibly highly correlated. With the benefit of hindsight, we can now see this clearly.

And I believe that retail investors’ highly-followed fintech companies were some of the most correlated. These were companies that may or may not be the disruptive future companies of the future.

But what I’ve also seen is that in the past few days, the market has started to bifurcate slightly, and it’s increasingly becoming a market of stocks rather than a stock market.

To illustrate my point further, consider how Netflix (NFLX) and Roku (ROKU) performed. Back in 2020, both these companies were strong winners. The market was not discerning. Yet today, the market is now attempting to sieve out the winners from the losers.

I believe that the same argument could be made about Snap (SNAP) and Pinterest (PINS). Snap is a company that has absolutely no plan to reach profitability anytime soon, in my opinion. Meanwhile, Pinterest is much more profitability focused, with less aggressive competition as a female-focused social media platform.

Sure, Pinterest has an abundance of problems, but its business model is slightly more geared toward delivering attractive profit margins in the future, rather than Snap.

And we could take this analysis one step further, and make the case that Snap’s business model is having to fend off strong competition from the likes of Meta (META) and TikTok (BDNCE).

Consequently, this is my firm contention. The market is today starting to discern the winners from the losers. There’s a new bull market underway and the leaders are right now being formed.

That’s not to say that every day will be easy. I believe that there are still going to be many false starts that will wear down investors when strong green days are followed by bleeding red days.

AFRM Stock Valuation – Less Than 5x 2023 Sales

Valuing companies on a P/Sales ratio is arguably the most superficial and error-prone way to value stocks.

And the reason why it’s so faulty is that it gives no weight to a company’s profitability profile. However, the reason why valuing companies on a sales multiple worked so well in 2020 was because we were in a bull market (a bubble?)

There was a coalescence of multiple factors from a burst of e-commerce to stimulus packages that made it appear at the time that the trees would grow to the sky.

Indeed, I believe that the market at the time was generally in the right ballpark. However, what I believe happened is that the market got slightly ahead of itself.

And similarly today, the market has got slightly ahead of itself by being very bearish on tomorrow’s disruptive tech companies.

Consequently, if we presume that Affirm’s business model was to significantly slowdown from the mid-40s% expected for fiscal 2022 (fiscal year already finished), and that Affirm would still succeed in growing in the mid-30s% CAGR in fiscal 2023 (ends June 2023), then the business could see close to $2 billion in revenues next year.

This would put Affirm priced at somewhere around 4x to 5x sales. This doesn’t strike me as egregious. This is only one turn more expensive than SoFi’s valuation, despite SoFi’s business model being even more questionable than Affirm’s. Why?

Because Affirm doesn’t have to carry anywhere near the level of loans as SoFi. From my point of view, SoFi is a bank. Call it a neobank, or a fintech business, or whatever. SoFi is a bank.

On the other hand, as the economy slows down and consumers’ spending power deteriorates, I suspect that many of the problems with defaulting customers that SoFi is likely to encounter, Affirm will also see.

On yet another hand, I make the argument that Affirm only accepts the highest FICO-scoring consumers, which would be less sensitive to a slowing economy.

The Bottom Line

In hindsight, investing is really easy. A lot of lazy investors anchor themselves to narratives that are easy to grasp and outdated.

However, consider this, back in the early 2010s, cloud stocks were extremely expensive. And at the time, investors would have looked nonsensical to make a rational valuation-based bull argument about those businesses too. But they would have been right. Because I believe that the market is a lot wiser than many investors give it credit for.

The same could be said about Tesla (TSLA). Countless investors, indeed some very high profile names, have shorted Tesla because it didn’t make sense to them. And they failed to recognize a changing of the guard because it didn’t conform with their way of seeing the investment landscape.

And now to go full circle. I believe that Affirm is going to positively impress investors with its fiscal 2023 guidance, when it reports on the 25th of August, after hours.

The business is unquestionably growing fast. It has managed to sign up ecommerce behemoths such as Amazon (AMZN) and Shopify (SHOP).

And if Affirm is able to convince the market that it has found a way to stop its losses and that it can carve out a path to profitability, I believe that investors paying $8 billion for Affirm are likely to be rewarded. Hence, I now rate Affirm with a tepid buy.