Why Coinbase Shares should not be Bought at Lows

From a fundamental point of view, investors now have obvious reasons to buy shares of Coinbase (NASDAQ:COIN).

Firstly, the securities have experienced a truly crushing collapse, having fallen in price by more than 80% since the beginning of November. A certain role in this was undoubtedly played by the fall of cryptocurrencies, but the idea suggests itself that the nervous market, perhaps, was selling Coinbase securities too aggressively.

Coinbase – weekly Timeframe Coinbase – weekly timeframe

The second reason is that Coinbase shares are absurdly cheap right now. Coinbase’s GAAP earnings for the past six months are more than $10 in recalculation per share. The company’s securities are currently trading at $65, and it turns out that the P/E multiplier is only slightly more than 6. This is one of the lowest multipliers in the entire stock market.

However, there is one catch: none of these two factors is actually a reason to buy Coinbase shares. If you look closely, you can see the reasons to stay away from them.

Binding effect

With regard to Coinbase and many other growth companies, one extremely important remark should be made: the degree of decline in shares, however, as well as the amplitude of their growth, does not matter.

Focusing on historical prices is a classic misconception known as the “peg effect”, in which investors, for some reason, perceive the past price as fairer than the current one. And this does not necessarily correspond to reality. Rather, more often it does not correspond to reality (here it is worth recognizing that current prices take into account more information, and this information is more relevant).

The fact that Coinbase was once valued at more than $60 billion is not so important. From a fundamental point of view, it is important that the company is still valued at more than $12 billion.

If we look into the future, and this is what we always do when investing, then Coinbase has yet to generate a profit with cash flow that justifies such an assessment. How much the company was valued in the past does not affect its fundamentals in the future.

Investors could learn about the danger of the binding effect from their painful experience, especially in 2000-2001 and 2007-2008. Given that so many low-quality companies received astronomical valuations in 2021, many investors, unfortunately, will probably have to learn this lesson again in 2022.

So are Coinbase shares cheap now?

Again, investors need to focus on the future, not the past. This applies not only to the share price of Coinbase, but also to the company’s profit.

Last year, of course, was extremely successful for this crypto exchange. The company made excellent money thanks to the high activity in the crypto market, which was flooded with individual and institutional investors.

The results of Coinbase for 2021 are simply incredible. The company’s total revenue increased by more than 500% compared to the previous year. Net profit attributable to shareholders-holders of ordinary shares increased 28 times.

The problem for Coinbase is that 2021 was clearly out of the ordinary. For the same reason, a moving multiplier of P/E equal to 6 does not mean that stocks are cheap. If we start from the reporting for the first quarter, Coinbase will record a fairly large loss for the full year 2022.

Adjusted EBITDA in 2021 amounted to more than $4 billion. In 2022, Coinbase expects a loss of about $500 million, which, in turn, means a net loss (even adjusted) of almost $700 million.

The weakness of the crypto market undoubtedly played a role here. The collapse of the Terra stablecoin further spoils the mood.

At the same time, Coinbase also has one long-term problem related to the take rate indicator. This indicator, which expresses, in fact, the amount of the commission, represents the share of volumes that the company records in revenue, and is calculated as the ratio of revenue to trading volume. In the first quarter of 2021, the company’s take rate reached 0.477%. A year later, the figure was 0.455%.

Not to say that this is a strong decline. However, given that quarterly volumes amount to hundreds of billions of dollars, the difference is significant. The indicator has decreased by almost 5% in just one year. And this lost revenue affects the margin, because those dollars almost entirely had to get into pre-tax profit.

At the same time, the decline in take rate is likely to continue. Competition with other exchanges, as well as with Robinhood (NASDAQ:HOOD), Block (NYSE:SQ) and other platforms, will lead to a decrease in the commission and take rate. Additional pressure over time will be exerted by an increase in the number of institutional investors, since most of them receive discounts for large volumes.

Coinbase needs a fairly consistent and strong volume growth, at least in order to neutralize this problem. To become profitable again after the expected losses of 2022, the company will need stronger growth. It is difficult to say that such a scenario supports an estimate of $12 billion, not to mention an increase from this level.

All is not lost yet

In fairness, it should be noted that all is not lost for Coinbase. “Bulls” can definitely make arguments in favor of the growth of stocks from the current level. This is what Wall Street seems to be waiting for: the average target price at the moment is $177, which means a growth potential of almost 200% from the current level.

Personally, I have serious doubts about this target. To be honest, I’m probably more skeptical about the crypt than most observers. If cryptocurrencies really become a legitimate, relatively stable asset class and institutional investors continue to invest in them, the results of Coinbase and the dynamics of its shares may recover.

In this case, the company’s business will not go as well as in 2021, but not as bad as in 2022. It will return to profitability, start generating real cash flow (possibly more than $1 billion according to the results of this year compared to last year), and its shares will significantly increase in price over time.

Such a forecast has reasonable grounds. However, it is important not to focus on an 80% drop in stocks since November or a moving P/E multiplier. This is exactly a forecast for the future. Personally, I don’t believe in him. But in the end, this is the only argument that remains either to believe or not.

At the time of writing, Vince Martin was not the holder of positions on any of the mentioned assets.

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