Is Now the Time to Buy Fintech Stocks?

You don’t need to be an expert to know that tech stocks of just about every stripe have taken it on the chin over the past year. The sector has been down more than 20% for most of the year. However, technology is a broad umbrella that can include hardware, software, communications equipment, information technology and telecommunications companies, so it is not a monolith. Some areas give better results than others.

A subset of technology is the growing field of financial technology, or fintech. Companies considered fintechs use technology to improve or automate financial services in some way. Of course, all financial companies rely on technology, but the term fintech usually applies to those where technology is the primary driver of the business – although the definition has become quite loose.

Throughout the bull market of the 2010s, fintech was the darling of both sectors – financial and technological – with big gains. It has been a different story in the past year as many have suffered heavy losses. Is now the time to buy fintech stocks? As always, it depends on the stock, but here are some things to consider.

Evaluation of fintechs

Many fintechs saw their share prices skyrocket coming out of the pandemic as more and more investors flocked to enjoy the ride. Some piqued interest by generating large revenue increases each quarter, while others were just picking up steam. This led to some ridiculously high valuations for companies, many of which were still not profitable.

Block (SQ 2.30%), for example, gained 247% in 2020. In August 2021, it was trading at over $275 per share – now it’s down to around $54. It was doing so hot that it had a price-to-earnings (P/E) ratio of 489 at the end of 2021.

It’s not unusual for growth stocks with smaller companies to have high valuations, but when they top out above previous levels, a red flag should go up for investors. This is especially true for companies that have not yet turned growing revenues into actual earnings. For companies with a net loss, you can’t look at P/E, but there are other metrics, such as price-to-sales and discounted cash flow, that you can use to determine valuation.

Image source: Getty Images.

It is not unusual for a small company to be unprofitable when it is in growth mode, as it invests heavily in its own growth. But eventually you will see those net losses narrow and turn into net income. If they don’t, it’s probably because the company’s revenue growth is slowing, or its costs are too high — or both.

Do they have a competitive advantage?

The other concern investors should be aware of when evaluating fintechs is their competitive advantage. Many enter the market because their technology often fills an unmet need or improves the status quo. But soon new competitors emerge, and the larger players can develop their own internal capabilities to handle that task, or acquire a firm that does.

The aforementioned block actually has some unique competitive advantages, as it serves both buyers, through its Cash App mobile payment portal, and sellers, through its Square division product line. It also has a bank charter that allows it to take deposits and arrange its own loans – saving money by eliminating the need to use a third-party bank.

SoFi technologies (SOFI 0.40%) has a similar advantage and, like Block, is one of the few fintechs that has a bank charter. In addition to offering banking services, SoFi also has an advantage with its technology platform, which it sells to companies looking to build out their own banking capabilities. This provides another income stream that has grown rapidly.

So as an investor it is important to do a deep dive into the company and the markets it operates in. Does its niche have many companies fighting for market share? Is its proprietary technology superior to the competition? Is that superiority sustainable? Does it have multiple streams of income in case one slows down? Who runs the company and is the management team effective? What is the cash and liquidity position, and is the debt manageable? Is it too dependent on a few large customers, or does it have a broad, growing customer base? These are just some of the items you should consider.

A fintech that can be too dependent on one customer is Market (MQ 6.45%), which provides a platform and infrastructure to facilitate payments. About two-thirds of Marqeta’s revenue comes from its partnership with Block. So it is Verify inventories,(AFRM 0.67%) a buy now pay later manager. But it’s in a newer industry that has tons of competition and has yet to turn a profit.

Proceed carefully

So, back to the question: Is this a good time to buy fintech stocks? No doubt it is because the valuations of many fintechs have crashed and are now at very reasonable levels. Block and SoFi are two that may warrant consideration due to their merits.

But investors need to be careful, especially in this economy, because rising interest rates are going to make it more expensive for fintechs to make capital investments and fund their growth.

Also, if there is a recession, fintechs that offer banking services or payments, or that work with banks and financial institutions, will be challenged by a slowdown in borrowing, lending and spending.

Those best able to generate consistent revenue during the downturn, and manage expenses, are likely to be the best candidates to emerge when the economy recovers from the current downturn. The key to finding them, as always, is to do your research.