SQ - ARKW: Tough Times Never Last But Bad Entry Points Haunt Forever

Summary

• We had given ARKW a sell rating, as the exceptionally poor fundamentals set up well with an overbought stock.
• The ETF has dropped 30% since then and begs a revisit.
• We update our short and long term forecasts.

When we last covered ARK Next Generation Internet Fund ( ARKW ) we gave it an emphatic sell rating. Specifically we said,

We stand by our target for ARKW to drop at least 90% from the all time peak and that would imply another 80% drop from here to under $20/share. We are downgrading this back to a Sell rating as the rebound has made risk-reward far more attractive.

Source: When Growth Is Ashes, You Have My Permission To Buy

We caught the local stock peak and ARKW swan dived at almost 2X the pace of the broader market.

We update our short, medium and longer term forecasts for this crowd favorite.

Fund Setup

When we looked at this last, the top 8 holdings were,

1) Tesla Inc. ( TSLA )

2) Roku Inc. ( ROKU )

3) Zoom Video Communications ( ZM )

4) Coinbase Global Inc. ( COIN )

5) Block Inc. ( SQ )

6) Grayscale Bitcoin Trust ( GBTC )

7) DraftKings Inc. ( DKNG )

8) Shopify Inc. ( SHOP )

ARKW has stuck to its core holdings and actually increased its deployment on some names. All 8 of those names are still in the top 10, Twilio Inc. ( TWLO ) making a notable jump up and SHOP moving lower a couple of spots.

This positioning is great from the point of view of having an opinion and outlook on the fund. If the fund is rapidly changing its holdings, any thesis needs to be changed just as quickly. It is also next to impossible to have a longer term view, as the fund may have a completely different set of holdings over time. ARKW has basically held the same companies since our first bearish call, and this allows us to again give longer term forecasts without trepidation.

Outlook

On our last coverage, we had shown this chart and suggested that growth stocks had a long, long way to fall, relative to value.

While ARKW has fallen and in fact has fallen twice as much as the S&P 500, have a look at the relative performance of growth and value segments since then.

Of course, ARKW did a good 10% more in losses than the iShares S&P 500 Growth ETF ( IVW ). That was not unexpected. But overall, the gap between growth and value has hardly closed. We would expect a huge outperformance of value vs growth, for a sustained period of time, before we can see ARKW reach the bottom. Looking closer within the value index ( IVE ), we find that if we remove the energy sector from the equation, value has done just as poorly as growth. Hence, we are looking for a lot lower prices for ARKW in the longer term.

Individual Valuations

Our contention has always been that this will end when all these holdings will become value plays and no one will want to touch them with a 10 foot pole. P/E ratios have compressed but still look rather outlandish today. So by that measure, none of these are even close to reaching bottom valuations.

Price to sales is looking better. Some of the compression there has been swift and brutal. Shopify Inc. has dropped from 45X sales to 6.3X sales. This is of course a good deal of the journey and we would keep our eyes out to pick this up at 1X to 2X sales in the coming year. That looks like another resounding drubbing, and well, it is. But if you see from the top, valuations have already dropped by 85% (45X sales to 6.3X sales). Bulls (you know who you are) cheering for this at 45X and being wrong for this entire journey should not start quibbling that the last 10% is way too much.

Another one we would like to touch on is Coinbase. The third largest holding of ARKW is easily the most fascinating one we can write about. The company came in at the tail end of a super bubble and fooled many value investors into buying the "value" at when it was trading at 15-20X unsustainable earnings in 2021. Those earnings are now gone and the company should rack up record losses.

Those losses are non-GAAP (GAAP losses should be 3X that) and come on the back of the single most ludicrous stock based compensation setup we have seen. Currently stock based compensation is at 50% of revenues.

Our estimates are that revenues will collapse by 50% over the next 1-3 quarters (from the Q2-2022 run rate) and that would give COIN the unique distinction of having more stock based compensation than revenues.

Verdict

On shorter timeframes, you should get a bounce and it could be nice. ARKW has been so far below its 200-day exponential moving average, for so long, that we would not rule out a "meet and greet" before more hell breaks loose on the downside.

Of course, if ARKW just went sideways for a while, the line would catch up.

Nonetheless, we think a bounce is more likely considering the sentiment. Note exhibit A from the Wall Street Journal below.

We are hence upgrading this to a "hold/neutral" rating.

On a medium term basis, we again think it will be frustrating for bulls and bears and possibly some consolidation before the final move begins.

The longer term forecast is decidedly bearish. ARKW holds easily the worst of the worst stocks, with exceptionally poor fundamentals and valuations still nowhere near where one could make an educated investment. For all the drop from the top, keep in mind that ARKW has now just caught up with QQQ.

We are revising our longer term target price to $15 to account for a more hostile monetary environment and no attempt by ARKW to rid itself of stocks like COIN.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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