STONECO – RISKY BUT REWARDING

This company has a lot of big names associated with it. Deep value investors like Warren Buffet, who owns ~5% of the company, to Cathy Wood of Ark investment, known for stocks on steroids. It only presents a delusional 9X opportunity if it can rebound to all-time highs. Peter Lynch suggested not to invest in a company purely based on the recent decline. “It has fallen 90%, how far low can it go?” The answer is that it can go to Zero.

StoneCo operates in the payments industry and is a pure finTech play. I am very optimistic about the opportunities. Brazil is a growing economy with a considerable underbanked population, which certainly provides the zing to the investment idea. Being in fintech gives the company the power to pivot. Like they did last year with Credit Solutions, but because the company is new, they may not have a lot of capital to pursue all options.
Moreover, The competition is growing, but I am optimistic about leadership and their decision. I believe in leadership as I found them honest. The last couple of earning calls makes it evident they accept and own their mistakes and look forward to fixing them instead of painting over the blunders. The PIX payment system and registry system present the challenges, so credit and working capital solutions might need some more work, and I might need to keep a closer eye on that space. Dependency on other lenders for credit solutions makes it a bit risky play because they might hold significant losses as soon as the capital market is tightened. Long story short, they have problems with credit, banking, and other value-added solutions. Still, their core business is firing on all cylinders, increasing active clients and total processing volume, and building an ecosystem of merchant solutions. Mind that all losses last year were made in credit and prepayment solutions, and because of that uncertainty, the stock is down 90%.

In the short term, in 1 year, I would like to see them fix issues with credit solutions and keep adding to their top line while maintaining the gross margins. In mid-term, 2-3 years, I would love them to come back to make a profit and uphold those operating margins. In a couple of years, I will evaluate how well they know their business when I cross-check their decisions today to fix their problems. I hope to see the fixes and hope they concentrate more on the core business.

So the big question is, what is the fair price to pay for StoneCo business? When looking at estimates company is expected to do 1.6 billion $ sales on avg in 2022 and 2 billion $ in 2023. They hope the company will return to profitability as soon as Q1 and report EPS of 0.76$ by 2023. Giving it a Forward PE of ~13.

To be fair, I have no idea how to value growth companies with wild profitability swings. All I can think of is to keep a very conservative view of growth assumptions and come up with a range. In the first valuation method, I tried to assume average growth of 8%, 12% & 18% for the next 5 years. I got a market cap of 5 Billion after 5 years which technically suggests a 10% CAGR from now on.

For the best-case scenario, I assumed variable declining growth for the next 5 years from 30% to 10%. I kept net income margins at 20%, which they did achieve in the past. I assumed an earning multiple of 20 as the company will grow at 20% yearly, giving it a PEG ratio of 1. If they can achieve that growth, the market will correct it’s multiple sooner or later. The best-case scenario gives me a market cap of 13.1 Billion dollars equaling 33% CAGR going forward.

I also tried the PS valuation metric to come up with a range. At first glance, I thought the current PS multiple of 3.35 is incredible because of my presumption that growth companies have higher PS multiple associated with them, i.e., Adyen has a multiple of 8. But I needed realistic multiples, and it turns out that the median market PS is 1.53. So I compared the multiple of 1.53 vs. 3 (As 3 still is a decent assumption for me from a growth perspective ). I came up with a range from 4.3 ~ 8.6 billion dollar market cap.

My range is from 1.3 Billion to 13 Billion. Potential 60% loss from current levels vs. 4 Bagger in next 5 years. It is in a high-risk and high reward category.

It definitely can crash 60% or even more in the short term because of overall market sentiment, geopolitical issues, or black swans, but that would not be permanent damage. I would love to buy it on its way down, assuming the story above remains solid. A potential 60% loss signifies fundamental business deterioration, i.e., Credit losses building up a massive pile of losses, Active client decrease, more central bank regulations, another disruptor disrupting StoneCo moat, etc.

I like to minimize risk instead of maximizing rewards, and I am not afraid to put most of my eggs in one basket, but this is not that kind of bet. I will start small and will add to it on its way down. If it ever reaches 1.3 billion USD or less market cap with the same fundamentals, I would be happy to make it a concentrated bet.

I am just a beginner, so please don’t take it at face value. As always, this is only for learning purposes. Don’t take it as investment advice, and always do your own research. I am planning to share my portfolio soon and write articles about why I own what I own to keep a book log as a reminder for myself. Until then, keep learning and keep investing. See Ya.

Disclaimer: Stocks discussed here are not recommendations. Please do your research before investing.