Why SoFi should not be priced as a bank
SoFi is a bank. It should not be priced like one. This is obvious to me but appears to be a sticking point for others, so I’m writing out a quick note to address this matter. Banks typically trade at single-digit price to earnings (P/E) multiples and often get valued based on their price-to-book value (P/B) or price-to-tangible book value (P/TB). I think that’s a ridiculous way to value SoFi.
Warren Buffett agrees that banks should not be priced on their book value
There is no other industry in which people look at book value as a primary metric for valuation. It’s often looked at as a value metric to determine a margin of safety. Why should a bank be any different? It shouldn’t. The current price of any equity should be the total of all future cash flows discounted back to their present value. Intellectually, the only reason it would make sense for a bank to be valued by it’s book value is if you believe that a bank's ability to generate cash is tied completely to its book value. Cash flow matters and earnings matter. Book value is a foolish way to value a bank. Warren Buffett agrees. He was asked about this specifically in 2013. Here is his response:
A bank that earns 1.3% or 1.4% on assets is going end up selling above tangible book value. If it’s earning 0.6% or 0.5% it’s not going to sell [above book value]. Book value is not key to evaluating banks. Earnings are key to evaluating banks. You earn on assets. Now, it translates to book value to some extent because you’re required to hold a certain amount of tangible equity compared to the assets you have, but you’ve got banks like Wells Fargo and USB that earn very high returns on assets and they sell at a good price to tangible book, you’ve got other banks, like maybe the two you mentioned [Bank of America and Citibank] that are earning lower returns on tangible assets and they’re going to sell below book.
I do not think that SoFi will be limited in their earnings potential by their book value. I think they will have a lot of non-balance sheet earnings through their financial services, tech platform, and their ability to sell their loans. If you believe that their growth and earnings will be completely limited by their book value, then by all means, use it as a metric for evaluating the company.
How does getting a bank charter lower the value of the company?
It also seems completely illogical to me that because they got a bank charter now they need to be valued by looking at their book value. Before they received a charter, this was never an argument. It’s never an argument for any other fintech. You don’t see people freaking out because PYPL is at 3.3 P/B, UPST at 3.5 P/B or NU (a bank) is at 5.8 P/B.
Did receiving a bank charter make SoFi a more profitable company? Does it make them more resilient to macro swings? Does it allow them to better serve their customers? Has it led to more growth? Does it provide a moat that distinguishes it from other neobanks? Has it significantly lowered their borrowing costs? The answer to all those questions is yes. So how does something that in every way makes the company better and increases its earnings potential mean that it should be less valuable when you go to price it? The mental gymnastics that it takes to think that something that makes a company more valuable should lead to a lower valuation is beyond me.
SoFi will have better margins and more earnings than a bank
If a bank should be valued by its earnings, then we should look at its earnings potential. SoFi has better earnings potential than classical banks because it has much lower overhead due to the fact that it’s a digital bank with no brick and mortar stores. Additionally, they own their full tech stack, meaning they get those services at cost, leading to better unit economics. It also has software revenue that other banks don’t have (more on this below). SoFi has better earnings potential than other banks, it should trade at a premium to other banks.
I don’t care if you sell rocks and dirt, microchips, or you’re a bank. If you grow your revenue earnings fast, your valuation gets a premium. You want to know why banks get single digit P/E multiples? It’s because they grow their earnings at low single digits. If SoFi can sustain 30%+ growth rates for a decade, it will trade at a huge premium, just like any company that has consistently higher growth than others in their same industry are given a huge premium.
Companies whose execution is better than their peers deserve to sell at a premium. Name one other bank with 9 straight quarters of revenue growth. Name one other bank whose deposits have grown at the rate that SoFi's have. Name one other bank who has over 6x as many customers as they did at the start of 2020. Name one other neobank who is seeing expanding NIM right now. Name one other bank that is seeing credit outcomes that are still below prepandemic levels. SoFi has done all of those. You might be able to pick out some bank somewhere that has done one or two of those things, you’re not going to find another one who comes even close to delivering on all of them. SoFi’s execution is better, it deserves a premium.
It’s a Fintech
Do you consider Amazon a cloud platform or just an e-commerce store? It’s obviously a cloud platform AND an e-commerce store. Do you know how much of Amazon’s revenues come from AWS? In 2022, it was 15.57%.
Do you consider SoFi a fintech or just a bank? It’s obviously a fintech AND a bank. Do you know how much of SoFi’s revenue comes from their tech platform? In 2022, it was 20.46%.
SoFi is not just a bank the same way that Amazon is not just a e-commerce store.
Valuations are nuanced
People love to look at a single number to determine if something is overvalued or undervalued. If it were that easy, then investing would be very simple. Turns out it isn’t that simple. Valuation takes a ton of nuance, context, and understanding of both past performance and future potential. The argument that “SoFi is a bank and should be valued like other banks” removes all the nuance and proper context for a true discussion of valuation.
SoFi is a bank. It’s more valuable as a company because it became a bank. It has higher earnings potential than every other bank because of its vertical integration and lack of physical footprint. It has other revenue streams besides its balance sheet. It’s growing at 10x the pace of other banks. It’s execution has outpaced the competition. You can value it however you want but if “just a bank” means it should be valued with a single-digit P/E multiple or based only on its P/B, then I think you are making a mistake.
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Thank you to everyone who has become a paid subscriber. I am now at 67% of my Tier 2 goal. As a reminder, I plan on ramping my content output as paid subscribers increase. Here are the content tiers:
Tier 1 – About 2 articles/month on the Substack. This is the level I’m comfortable at for now with what I’m making.
Tier 2 – A minimum of 4 articles/month on the Substack
Tier 3 – Add a Weekly Twitter Spaces where I can engage better with followers and answer questions people may have
Tier 4 – I’ll start a Youtube channel and do at least one weekly video. Some ideas I have for the channel would be to present my articles as videos, discuss the basics of options, how I approach portfolio building, finances, my overall investment philosophy, a “Fundamentals of SoFi” series to lay out key concepts of the company, etc.
Disclosures: I have a long position in SOFI.
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