In my previous article, https://marketzen.quora.com/What-s-In-Warren-Buffett-s-Tech-Bag, I identified six tech stocks held by Warren Buffett’s Berkshire Hathaway. In this article, I will take a closer look at two of them: Nu Holdings (parent company of NuBank) and StoneCo, fintech companies operating in Brazil, Colombia, and Mexico. Relying on soft information that Berkshire Hathaway invests very selectively in great businesses, we can infer that NuBank and StoneCo are great businesses. The question is whether these companies are fairly priced at this moment; to do this, I will compare price to book value, revenue, and profitability.
For context, the U.S. has a population of approximately 330 million people and over 4,300 depository institutions (https://www7.fdic.gov/sdi/main.asp). By contrast, Brazil has a population of about 212 million, two-thirds the size of the U.S., but has only about a dozen large banks (https://banksdaily.com/world/Brazil). I could not find information on smaller regional banks, but this paints a picture of an industry controlled by few legacy companies, high monopoly power, limited reach in rural areas, and most likely inefficient/high-cost operations.
Being tech-centric, NuBank and StoneCo have an opportunity to compete at a higher scale, lower average cost, and higher profit margin than legacy banks. If the fintechs can achieve very high volume (measured by revenue and number of customers), they will dominate the banking industry — one day. As leaders in fintech, they also have the opportunity to erect barriers to entry (“moats”, as Warren Buffett calls them) to discourage new entrants to fintech; this includes providing cheaper services than new entrants, making it difficult and costly to switch, and even buying the competition out of existence.
It’s important to note that NuBank and StoneCo are not competitors. NuBank markets to consumers, providing online checking & savings accounts, credit cards, and loans (similar to Sofi in the U.S.). StoneCo provides payment solutions to merchants (similar to Square, now Block in the U.S.) .
Book value is one of the key metrics for Warren Buffett and value investors. It is the net tangible assets (total assets minus liabilities) reported on the balance sheet. It answers the crucial question: in the worst-case scenario, if the company is in dire need to sell off its assets, what will be left for investors?
For historical context, bankruptcies and liquidations do happen, albeit infrequently. When it does, it really hurts. Some notable examples are Enron, Worldcom, and dozens of financial institutions in the 2008 financial crisis (Bear Stearns, Washington Mutual, etc.); their demise led to the sale of individual assets (buildings, equipment, etc.). This is when it really matters to investors that they can recoup as much of their investment as possible.
To drive home the point, this would be the same question that one would ask when considering whether to take on more debt to buy a house: “what will I have left if I am forced to sell my house and pay off my debts?” If the answer is “not much”, then the investment would be highly risky and ill-advised.
Using the latest available data, 2020, I compare NuBank and StoneCo in the table below. For comparison, I added PagSeguro, a Brazilian fintech competitor to StoneCo not owned by Berkshire.
The middle column tells us that investors would be able to recover at maximum $.09, $4.93, $4.73 per share from NuBank, StoneCo, and PagSeguro respectively, if these businesses had a fire sale. The higher the number in this column, the better. But, we have to put this context described below.
When buying a business, investors should be prepared to pay a price premium higher than book value, but not too high. To perform this calculation, we divide the share price by book value per share, shown in the last column. The lower the resulting ratio, the better.
Benjamin Graham, Warren Buffett’s mentor, advised that the Price-to-Book-Value ratio greater than 1.5 is too expensive, and any positive number between 0 and 1.5 is fair. In other words, a stock investor should not pay more than 50% premium over a company’s book value. By this standard, StoneCo is the most fairly priced, PagSeguro second, and NuBank last.
Surprisingly, even by one of Warren Buffett’s favorite metrics, NuBank is extremely expensive. For it to be more attractive, the price has to come down a lot, its assets would have to be assessed at higher values, or the company has to pay down its liabilities by a lot (or some combination of these things). The best thing going for NuBank is that it has first-mover advantage in the consumer fintech in Brazil.
Key Takeaway: StoneCo is the most attractively priced on a price-to-book-value basis.
Without revenue (sales), there would be no profits and a viable business, so this is another key metric. The table below gives us an idea of the each business’ growth rate over time, and its size relative to competitors’ (market share).
Table 2 shows that PagSeguro is the largest fintech by revenue/market share — all fintechs experienced an impressive 35%-55% compounded annual growth rate (CAGR).
Also shown in the table are revenues for the legacy banks in 2019, the latest available year (https://www.statista.com/statistics/954704/leading-banks-brazil-financial-services-revenue/). It is striking that fintechs’ revenues pale in comparison to the legacy banks’; NuBank, StoneCo, and PagSeguro’s combined revenues were less than even the smallest legacy bank’s (Safra) in 2019. Furthermore, fintechs’ combined market share is 1/100th the size of the legacy banks’ market share. This underscores the tremendous opportunity for the fintechs to take market share from the legacy banks.
Next, we evaluate whether the fintechs are priced fairly relative to revenues, shown below, using 2021 data.
In addition to paying a premium over the net tangible assets, investors should also expect to pay a premium for the revenues generated by the business. We calculate the premium (or discount) by calculating the price-to-revenue ratio (last column in the table). We want the lowest possible ratio (resulting from higher sales for a given price). As a rule of thumb, the price-to-revenue ratio should not exceed 10.
Key Takeaway: PagSeguro is the most attractively priced, having the lowest price-to-revenue ratio. StoneCo is also attractive, with a ratio below 10. NuBank looks way too expensive.
Finally, we assess price attractiveness based on profitability as measured by fully diluted net earnings — earnings spread across currently outstanding shares plus yet-to-be-issued shares (convertible bonds, employee stock options, etc.).
It is important to note that NuBank operated at a loss of 4 cents per share in 2020 — quite rare for a Warren Buffett-backed company to be losing money.
The higher the earnings pers share (EPS), the better. PagSeguro comes out on top on EPS. The next question is: are the current share prices fair relative to EPS? To answer this question, we divide share price by EPS, giving us the price-to-earnings (PE) ratio in the last column. The lower the PE ratio, the more attractive the price. As a rule of thumb, a reasonable PE should be between 10 and 20.
Note that in 2020, PagSeguro and StoneCo looked attractive on PE basis, but full-year 2021 earnings have not yet been reported. At this point, StoneCo has reported that it lost $100 million in the first three quarters of 2021. PagSeguro and NuBank will probably report losses for 2021 as well.
Given that we have incomplete data for 2021, I will refrain from making conclusions about price attractiveness on a PE basis at this point.
Key Takeaway: It’s too early to call the clear winner on the basis of PE ratio, since we are still waiting for the full-year 2021 earnings reports.
Based on the first two criteria of determining price attractiveness (price-to-book-value and price-to-revenue), StoneCo and PagSeguro are tied, while NuBank lags behind. Based on the price-to-earnings multiple, though, the jury is still out, due to incomplete data; I will update this article once all the data are available for 2021.
I close with two unanswered questions:
- Why does Berkshire Hathaway prefer StoneCo over PagSeguro when PagSeguro is larger and has better price-to-revenue valuation than StoneCo?
- Why did Berkshire invest nearly $1 billion in NuBank when it is extremely overpriced and operating at a loss?Perhaps I will be able to answer these questions in future articles as more information becomes available.
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