Jhe Nasdaq Compound didn’t have a good year. Down nearly 29% so far in 2022, it has been the hardest hit of the three major indices. Long-term investors have probably seen their portfolios take a hit like everyone else, but they know that such a steep drop is likely to create buying opportunities for those with the right investment mindset.
Let’s take a look at two of the Nasdaq Composite’s worst performing stocks in 2022 and see if buying the dip is warranted.
1. Interactive Platoon
The story behind the connected fitness company’s struggles is a pretty simple story of supply and demand. During the pandemic, when gyms were closed, exercise enthusiasts sought alternatives that accommodated social distancing, and stimulus checks inflated purchasing power, demand was so high for Interactive Platoon (NASDAQ: PTON) products that the company could not keep up with.
This excess demand led the company to invest massively to increase its production capacity. As the pandemic subsided and vaccines allowed people to congregate again in fitness centers, demand for Peloton products fell sharply, along with the need for increased production. Layoffs and changes in plans and outlook soon followed. The stock price fell with it, down 94.5% from highs reached in February 2021.
The question now is, is Peloton a worthwhile investment or is there a payback opportunity here?
Peloton’s record so far suggests potential problems. In its latest report, Peloton management said the company had $879 million in available cash versus more than $1 billion in current liabilities. This led Peloton to add an additional $750 million in long-term debt to its books to fund stimulus efforts. While this is good news in the short term (the company will be able to pay its immediate obligations), it will have to work hard to improve its balance sheet in the coming quarters.
The income statement also suggests problems. The biggest red flag is a massive increase in operating expenses. For nine months in fiscal 2022 (as of March 31), Peloton had $2.25 billion in operating costs, up from about $1 billion the year before. That’s a jump of 107% year over year. During that same nine-month period, revenue fell 6% year over year.
Due to lower demand and rising costs, the company now has negative cash flow so far in 2022 after reporting positive cash flow at the same time in 2021. Based on revenue, it recorded a loss of $1.5 billion in the last quarter.
The finances are therefore not in very good condition at the moment. It’s hard to find a silver lining with Peloton, but if there is, it’s in the company’s new CEO, Barry McCarthy. In a recent letter to shareholders, McCarthy said the company’s No. 1 goal is to be cash flow positive as soon as possible by reducing costs and growing higher-margin revenue through its subscriptions. .
McCarthy also detailed a very ambitious long-term goal of reaching 100 million subscribers. He currently has around 3 million subscribers. If the company achieves even half of this target, the company should do well and the stock should produce excellent returns. But that’s a big “if” right now and there are too many red flags that need to be addressed before investors take a chance on this company again, even those with a long-term mindset.
2. Assets received
Another stock that has been punished recently is Assets received (NASDAQ: UPST), which is down 91.6% from all-time highs set in November 2021. Similar to Peloton, a changing macroeconomic environment has been a strong contributor to the crater in stocks. But the specific reasons were different.
While Peloton saw its demand evaporate almost overnight, Upstart has a lot of demand for its AI-powered loan origination platform. But with interest rates rising and the market shifting towards lower-risk investments, Upstart could well be a quality company caught in the macroeconomic crossfire.
For starters, the company’s balance sheet looks much healthier than Peloton’s. It has approximately $1 billion in available cash, which is significantly more than its current liabilities. Upstart also increased revenue by 156% and profit by 224% in the last quarter. These are not the results of a failing business.
So why did the stock price crater? For one thing, the company’s valuation last fall had entered absurd territory, at one point trading at a price-earnings ratio of nearly 500:
But the biggest issues for the stock are probably related to rising interest rates and the temporary introduction of loans to the company’s balance sheet. Rising interest rates could be bad news for the company, as it will undoubtedly lead to lower personal loan applications and increase the risk of default among loan recipients. But adding debt to the company’s balance sheet is the main concern.
Until recently, Upstart was purely a marketplace for banks to more efficiently underwrite loans that Upstart believed should be approved. Upstart collected fees from the banks to facilitate the transaction. This made Upstart a software-as-a-service company. But recently, Upstart expanded its loan approval system to include auto loans and underwrote a small portion of those loans itself to help it develop the AI algorithms needed to better predict which loan applicants should be eligible. This was a short-term R&D investment. With the company now directly underwriting a small number of loans, it adds a banking element to the business model.
Bears on the stock say it’s hard to justify a premium valuation if Upstart is essentially just another bank, but CEO Dave Girouard said in a recent interview with the co-founder and CEO of Motley Fool, Tom Gardner, that it was a short-term strategy that was more reflective of Upstart’s struggles with price discovery – figuring out how to rank a loan seeker’s cost – than a model evolving business.
As Girouard explained: “[W]what happened is that the markets suddenly turned around, and our price discovery process is not fast enough to get prices where supply meets demand, and when we had that imbalance, if you will, we took some [loans] in our balance sheet, and we have no intention of doing so. It’s none of our business, and we’re going to improve the tools to make price discovery happen faster.”
While the macro chart depicts a lot of near-term uncertainty, strong demand from its banking partners shows Upstart’s alternative to Just IsaacFICO subscription works. If the company can firm up its price discovery algorithms for the new segment, the current valuation looks quite attractive for investors with a long time horizon.
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Mark Blank holds positions at Upstart Holdings, Inc. The Motley Fool holds positions and recommends Peloton Interactive and Upstart Holdings, Inc. The Motley Fool recommends Fair Isaac. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.