Shares of fintech firm SoFi Technologies (NASDAQ:SOFI) surged nearly 20% on Monday after the company reported its first-ever profit. Media reports salivated over the 2-cents-per-share earnings, driven by a 44% jump in total new members and strong performance from its tech platform and financial services segments.
More upside is likely on the way.
SoFi’s fourth-quarter numbers show that the firm has also successfully attracted customers beyond its original base. During the quarter, the San Francisco-based firm saw over 84% of its new product sales come from new customers, well above the 65% figure seen a year ago.
The online bank is also rapidly expanding its financial services products, a far more lucrative business than its traditional lending segment. Fixed deposit accounts cost SoFi virtually nothing to maintain beyond regulatory reserves, since the company has no physical locations to fund. And relatively high U.S. interest rates mean that the company’s Money (investments) and Relay (savings accounts) products now almost break even, despite barely reaching scale.
Together, that’s why I’m raising SoFi’s price target this month from the $10-$15 range to $12-$17. Not only has this fintech firm proved that it’s possible to convert existing low-margin clients into higher-margin ones. It’s also shown a stunning ability to attract high-margin clients out of thin air.
SoFi’s Growth Story
In truth, SoFi’s success was never guaranteed. Many traditional firms have tried its business model before — using one financial product as a loss leader to cross-sell more profitable ones. And while some industries like wealth management have earned billions from doing this, plenty more have failed. Bank of America (NYSE:BAC), for instance, converts fewer than 15% of their banking customers into investment accounts.
But SoFi has managed to perform magic in an old-fashioned way. By peppering potential customers with mailed and electronic ads, cash reward offers, and free services like financial planning, SoFi has managed to keep its business growing even as traditional banks stand still.
Word of mouth is also playing a role. In Q4 2023, SoFi saw its new customer adds accelerate from 480,000 to 585,000, even without adding to its marketing budget. Its lack of physical locations also keeps customer acquisition costs under $300 per customer. Companies like Bank of America routinely spend twice that amount for new accounts once you include the costs of maintaining their physical footprint.
That gives SoFi an unusual amount of upside. SoFi has no physical locations, so it is not geographically limited to any single region. Its willingness to cross-sell products from other providers (and eventually horizontally expand into the most lucrative areas) has also given SoFi more products to sell — all without needing expensive acquisitions.
In addition, SoFi’s shares still trade only at 1.4 times book value, well below slower-growing competitors like Discover Financial Services (NYSE:DFS) (1.8x) and OneMain Holdings (NYSE:OMF) (1.9x). In March 2023, I argued that SoFi’s fair value fell somewhere between $10-$15, a 150% upside at the time. Its new $12-$17 range now prices SoFi in the 2.6x book value range, or 33 times 2026 earnings.
The Risks of SoFi Stock
Of course, an investment in SoFi comes with significant risks. Firstly, the company is still a bank, which creates banking-sized risks. Internal risk management teams routinely underestimate potential loan loss ratios, and SoFi’s relatively young age makes it particularly prone to these errors. Peer-to-peer lending firms like Lending Club (NYSE:LC) fell into the same traps after falsely assuming that young professionals would maintain the near-zero default rates seen in early cohorts.
Secondly, SoFi’s focus on student borrowers exposes the firm to systemic risks. A sudden downturn in the economy, for instance, could cause loan defaults to rise and deposits to fall at the same time as young borrowers draw down their savings. Because the firm does so much cross-selling, a blow-up in student loans might also trigger a bank run.
Finally, SoFi is not ranked by MarketMasterAI, the AI system I use to grade stocks. Bank balance sheets are too complex for AI models, since their financial risks fall outside what generally accepted accounting principles (GAAP) can detect. No consolidated balance sheet, for instance, would have “shown” the subprime mortgages that eventually sank Lehman Brothers. Even Louis Navellier’s quant-based system is wary. SoFi receives a “C” grade for its worryingly slow earnings growth relative to sales.
The Bottom Line
But that’s what gives SoFi such enormous upside. For most of the 2020s, markets have become fixated on the risks around SoFi’s business model and priced shares accordingly.
However, the company’s fourth-quarter earnings will reduce many of those fears. Even though SoFi still carries the risks of a bank, its management has proven that old-fashioned business models can work with the right touch. Shares today have a 60% upside.
On the date of publication, Thomas Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.