Why Affirm Holdings plummeted 34.7% in February

What happened

shares of confirm participations (AFRM -1.13% ) according to data of 34.7% fueled in February S&P Global Market Intelligence. Buy Now, Pay Later (BNPL) provider posted strong growth numbers in its second-quarter earnings report, but investors were worried about mounting losses, sharp increases in marketing spend and a big spike in loan losses.

so what

On February 10, Affirm reported its second-quarter results, covering the three months ended December. Revenue growth was strong during the period, rising 77% to $361 million, comfortably beating expectations of $329 million before the announcement. When you see this number, you might think that Affirm stock has skyrocketed in the days following the report. But that is not the case.

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To drive 77% revenue growth, Affirm increased its marketing spend 267% year over year to $143 million and its provision for loan losses by 320% to $52.6 million. Marketing spend exceeding sales suggests Affirm is having a harder time finding new customers to grow its BNPL business. Loan loss provisions, which are growing faster than revenue, show the company is reaching out to borrowers who are less likely to repay those short-term loans. Neither trend is good for Affirm’s business. Overall, this deterioration resulted in an operating loss of $196 million in the second quarter.

Additionally, Affirm’s stock is likely to be under pressure due to the turmoil over there Peloton Interactive. The at-home fitness company uses Affirm to help customers finance their purchases. When the company said demand for its products had eased, investors likely took it as a sign that Affirm’s growth will also be hit.

What now

Right now, Affirm Holdings has a market cap of $11.4 billion. Based on expected sales guidance of $1.3 billion, the stock is trading at a price-to-sales (P/S) ratio of 8.8. That’s not too expensive for a fast-growing company like Affirm.

However, the key metrics investors can track with Affirm aren’t P/S or revenue growth. To be a good investment over the long term, the company must properly size its marketing spend and credit losses, and eventually start generating profits and cash flow. It doesn’t matter how much revenue you generate if you lose money.

If it doesn’t, Affirm’s stock looks incredibly overvalued, even though shares are down 60% year-to-date. That doesn’t mean Affirm stock is guaranteed to be a bad investment, but it’s a very risky stock right now, and there’s no reason it can’t fall much further if things take a turn for the company over the next few weeks years don’t change years.

This article represents the opinion of the author, who may disagree with the “official” endorsement position of a Motley Fool premium advisory service. We are colourful! Challenging an investing thesis — including one of our own — helps us all think critically about investing and make decisions that help us be smarter, happier, and wealthier.

Virginia C. Taylor