TDOC - ARKG: Despite A Huge Price Loss In 2022 Not The Right Time To Accumulate

Summary

• ARK Genomic Revolution ETF invests in small-cap and mid-cap companies engaged in genomic revolution, i.e., in the research of genomic sequencing, analysis, synthesis, or instrumentation.
• Alpha-generating stocks ARKG selects from time to time and backs for a longer time period have in general generated strong returns. Sadly, this is not the case this time.
• Forecasting an alpha-generating stock and backing it for a very long period is a risky proposition, something ARKG has been able to do successfully over the past years.
• Despite a huge ARKG price loss during the past two years, the price multiples are still around the category average, and the price is yet to come down to my target price level.

~ by Snehasish Chaudhuri, MBA (Finance).

Over the past year, I have set a price target of $25 or less in order to accumulate stock of ARK Genomic Revolution ETF ( ARKG ). I have repeatedly said that ARKG is suitable for long-term growth-seeking investors. On various occasions, I found the exchange-traded fund ("ETF") delivering a positive outlook with respect to the three basic criteria for backing this fund: a) future growth prospects of Genomics Revolution; b) current price multiples; and c) efficiency of portfolio reshuffling. However, I did not feel those were the right times to accumulate this fund primarily due to it not falling below my price target. I’ll again try to figure out whether it's time to take some position in this stock.

ARKG Bets on Genomic Revolution and Banks on Alpha-Producing Stocks

ARK Genomic Revolution ETF, as the name suggests, invests in companies that are engaged in genomic revolution, i.e., the research of genomic sequencing, analysis, synthesis, or instrumentation. ARKG has invested in companies dealing with "Beyond DNA" (21 percent), Molecular Diagnostics (17.3 percent), Bioinformatics (13.2 percent), Instrumentation (12.8 percent), Gene Therapy (12.6 percent) Targeted therapeutics (11.8 percent), and Next Generation Oncology (11.2 percent). Almost 90 percent of these companies are small-cap and mid-cap biotech firms. ARKG has an expense ratio of 0.75 percent and an asset under management ("AUM") of $1.84 billion. The fund doesn’t pay regular dividends and generates a low yield mostly between 1 to 2 percent. It recorded a trailing-twelve-months (TTM') yield of 1.35 percent.

During my last coverage on September 29, 2022, I mentioned that:

“[T]he fund does some effective reshuffling from time to time, which backs some alpha-generating low-priced stocks, and sells out one or two large-cap biotech stocks in order to finance these acquisitions. The fund also makes sure that the stocks which it is betting upon stays in their portfolio for a longer period of time. I am impressed by these particular qualities of the ARK Genomic Revolution ETF. Forecasting an alpha generating stock and backing it for a very long period of time is an extremely risky decision, which ARKG has been able to achieve successfully over the years.”

An alpha generator stock delivers returns that are considerably higher than its peers without undertaking any substantial risk.

For A Change, the Portfolio Reshuffling Failed to Deliver Results

During the portfolio reshuffling during Q3, 2022, ARKG reduced its investments in Vertex Pharmaceuticals Incorporated ( VRTX ) and Pacific Biosciences of California, Inc. ( PACB ) and enhanced stakes in Accolade, Inc. ( ACCD ), Ginkgo Bioworks Holdings, Inc. ( DNA ), Verve Therapeutics, Inc. ( VERV ) and Schrödinger, Inc. ( SDGR ). DNA is involved in developing platforms for cell programming. VERV is engaged in developing gene editing medicines for patients to treat cardiovascular diseases. SDGR creates software platforms that enable discovery of novel molecules for drug development. ACCD develops technology-enabled solutions applicable for the healthcare system.

Generally, the stocks in which ARKG increases its allocation generate strong results, and the stocks in which it reduces its allocations fail to generate strong growth. However, for an exception, the results are really disappointing this time. DNA, SDGR, VERV, ACCD - all these four stocks generated a price loss between 25 to 50 percent during the past 3 months. At the same time, PACB grew by 41 percent. No surprise that ARKG has increased its investments in PACB in the reshuffling made during Q4, 2022. Currently, PACB accounts for 4.81 percent of its entire portfolio of investments.

ARKG this time has made significant investments in Adaptive Biotechnologies Corp. ( ADPT ), Veracyte Inc. ( VCYT ), and UiPath Inc. ( PATH ) - another three alpha generating stocks. ADPT posted a price growth of 13.2 percent and VCYT grew by 41 percent. PATH made a price loss of only 3 percent. Other large holdings of ARKG, such as Exact Sciences Corp. ( EXAS ), Incyte Corp. ( INCY ) Ionis Pharmaceuticals Inc. ( IONS ), and Teladoc Health Inc. ( TDOC ), delivered relatively better returns considering the performance of the broader market. During the past 3 months, EXAS and INCY grew by 45.5 percent and 17 percent, respectively. TDOC and IONS fell by 11.5 percent and 16 percent, respectively. Together these 8 stocks weigh 40 percent of ARKG’s portfolio.

Is Investing in ARK Genomic Revolution ETF A Highly Risky Proposition?

ARKG, meanwhile, is trading at $28.23, and lost 54 percent of its value during 2022. It also suffered a loss of another 34 percent in 2021. Average total return generated between the period 2017 and 2021, however, stood high at 47.5 percent. This happened primarily due to an overwhelming total return of 180 percent during 2020. However, despite huge price losses during the past two years, the price multiples are still around the category average. I expected ARKG’s price multiples to be significantly lower than its peers or related indices. But, a price/earnings of 17, and Price/Cash Flow of 87.95 can in no way indicate the stock is undervalued. Only the Price to Book value (P/B) ratio is considerably low (1.54) relative to its category.

Last time, I mentioned Cathie Wood’s strong views about a possible miscalculation on inflation on the part of the Federal Reserve. She stressed on the risk of deflation and highlighted the fact that unlike other high inflationary periods, gold was no longer the safest investment option. All the funds of this $60 billion ARK Invest (an investment firm founded by Cathie Wood), including ARKG, was thus expecting a turnaround on their fortunes and had gone for aggressive investments. For the time being, such a turnaround in fortunes seems to be a faulty assumption. Moreover, ARKG is on a mission to identify the leaders of the genomic revolution, but their extremely long-term plans make the fund and its portfolio exceedingly hard to understand. In that sense, ARK Genomic Revolution ETF no doubt is a relatively high-risk fund.

ARK Genomic Revolution ETF is a Futuristic Fund and Requires Patience

In an earlier coverage during February, 2022, I mentioned in detail about the prospect of genomic revolution, and also the need to have a long-term view on that. I argued that:

“Within another 30-40 years, the Genomic Revolution is going to revolutionize cancer detection, DNA sequencing, living drugs, and agricultural biotechnology. Understandably the companies focusing on Genomic revolution have long-term growth prospects. The same goes for ARK Genomic Revolution ETF, which is a theme based fund….the constituent biotechnology firms of ARKG's portfolio will be engaged in the developing, producing, manufacturing or enabling bionic devices, bio-inspired computing, bioinformatics, molecular medicine and agricultural biotechnology. All these technologies can only deliver results over a long time. So, a fund like ARK Genomic Revolution ETF needs to be evaluated over a long-term horizon.”

In my opinion, ARK Genomic Revolution ETF does have strong future growth potential, but at the same time bears the risk of being a good prospect which fails to deliver returns. This thematic fund’s portfolio is heavily tilted towards volatile small-cap and mid-cap pre-profit companies which may or may not succeed over the long run. The alpha-generating stocks ARKG selects from time to time, and backs for a longer time period, have in general generated strong returns. Sadly, this is not the case this time. However, that should not be a concern for investors who believe that the genomic revolution is a disruptive force and want to be an early mover. For conservative investors, this portfolio of highly volatile yet-to-be proven stocks may not make much sense.

Investment Thesis

Forecasting alpha-generating stocks and backing those for an extremely long period is an extremely risky proposition, something ARKG has been able to perform successfully over the past years. Poor returns from alpha-generating stocks in one quarter does not make this portfolio a poor performing one. Moreover, its top picks have performed much better than the broader market.

However, ARK Genomic Revolution ETF still doesn’t seem to be undervalued, despite the huge price losses suffered during two successive years. As I never doubted the future prospect of genomic revolution, I’d still continue to back this fund. However, as mentioned in all my past coverages, I’d suggest accumulating ARK Genomic Revolution ETF only when its price falls down below the targeted price level of $25.

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