Why the Bulls Are Still Wrong About Affirm Stock

There’s an old trading adage that goes as follows. A stock that is down 90% is one that was down 80% and then got cut in half again. This is precisely what’s happening for many unprofitable and speculative companies such as Affirm (NASDAQ:AFRM) stock. AFRM stock is now down 80% from its 52-week highs, leading many traders to think that shares are now cheap.

However, Affirm holders may find that 80% decline soon turning to a 90% decline as the share price continues to crash. In fact, at the end of the day, there’s a decent chance that Affirm will ultimately end up close to worthless.

Long story short, financial technology companies are among the riskiest ventures out there, and Affirm’s day in the sun has ended. The company now faces a long dark night ahead.

A Company Built Around a Gimmick

Affirm is a company based around what’s called “buy now, pay later” (BNPL) lending. Buy now, pay later allows consumers to purchase goods today and pay for it at a later time. Often, this is permitted without any interest charges.

If BNPL doesn’t sound very innovative, that’s because it’s not. America has had rent-to-own, leasing, buying over time, layaway and various other options for creative financing of consumer goods for decades. And, of course, credit cards themselves allow consumers to buy something now and pay later. Most credit cards charge interest, of course, but savvy consumers are able to find cards with no interest for a certain number of months or other such maneuvers to get interest-free purchases.

In other words, BNPL is merely a slightly new flavor of a very old lending tactic. And, in fact, numerous overseas markets have supported BNPL for decades. In some Latin American countries, for example, whenever you check out with any credit card, they ask you how many “quotas” — or months of payments — you want for your purchase. The retailer accepts the credit risk for payments and it’s all automatically handled through Visa (NYSE:V) or Mastercard (NYSE:MA) with no third party needed.

Into this BNPL landscape, companies like Affirm and Afterpay, now part of Block (NYSE:SQ), have entered. Fundamentally, they’re just offering another version of a short-term loan product. This is nothing disruptive or exciting, it’s just plain old consumer lending. That said, lending is one of humanity’s oldest business models. Is Affirm a good lending operation?

Losses as Far as the Eye Can See

In short, no, Affirm has not proven any particular skill at its craft. Over the past quarter, Affirm generated $361 million of revenues. In doing so, it generated an operating loss of $196 million. That’s a negative operating margin of 54%. For every dollar that Affirm brings in from its installment loans, it loses 54 cents.

Needless to say, any traditional bank that loses more than 50 cents per dollar of interest it receives would soon be bankrupt. Is Affirm different because it’s a FinTech company instead of a bank? No, not really. It’s still lending. And in lending, if you don’t generate enough interest to cover your expenses, you won’t be long for the world.

Bulls used to tout Affirm’s revenue growth. But, in lending, top-line revenue is meaningless. You can always generate more revenues by making bad or risky loans. You typically don’t want to invest in the fastest-growing banks because they may be cutting corners on their loan underwriting to achieve such rapid growth. In the case of Affirm in particular, its operating margin has been getting worse lately anyway, so it’s not like the business is achieving scale as it gets bigger.

Affirm’s Peloton Partnership

How has Affirm grown so quickly? In part, because it has been willing to lend against assets of dubious value, to put it kindly. One of Affirm’s key partners is Peloton (NASDAQ:PTON). Peloton was a hot smart bike maker for a minute back in 2020. However, as the quarantines ended, demand collapsed for Peloton bikes. Now many of them are being used as clothes racks or otherwise sitting in a dusty corner of peoples’ basements.

Peloton shares have plunged more than 80% from the highs and the company has engaged in massive layoffs and production halts to stem its bleeding. Affirm was a huge source of financing so people without cash on hand could buy Peloton bikes. Will people keep paying off their loans for bikes that they’ve stopped using? Only time will tell.

In any case, that sort of empty calorie growth for Affirm is now running in reverse. With inflation spiraling out of control and people starting to hunker down for a potential recession, look for spending on frivolous consumer goods to drop sharply after 2021’s euphoria. And, in case, Affirm loses massive amounts of money on the revenues it does generate regardless.

The Bottom Line

It’s fitting that so much of Affirm’s apparent success was tied to Peloton. It was a fad fitness machine powered an equally unnecessary lending product. And now, both are plunging together as the stay-at-home tailwinds disappear.

Perhaps AFRM stock can try to slash its overhead and carve a path to profitability. However, given the massive scope of its losses during a consumer spending boom, it’s hard to imagine that Affirm will ever be successful. If it couldn’t make money in 2021, what set of conditions could possibly be better?

On the downside, imagine if we get a recession and people stop paying their installment loans. Affirm couldn’t even make money during an economic boom. Watch out if and when a recession hits.

On the date of publication, Ian Bezek held a long position in V stock. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.