SoFi Technologies (SOFI -0.85%) just reported solid 2024 first-quarter results. Revenue jumped 37% year over year, and the digital-banking provider posted its second straight positive-net income. These are encouraging signs.
Nonetheless, the fintech stock remains about 72% off its peak price (as of May 6). Investors looking to score huge long-term returns might have their eyes on this business, especially as it has potential to continue growing sales and earnings over time.
But before you buy shares, you might want to understand this little-known risk SoFi faces.
Moving away from the core
SoFi was founded in 2011 with the sole purpose of helping students finance their education. But what started as a student-loan provider has now transformed into primarily a lender of personal loans. This changing loan book is the risk investors need to know about.
In the past 12 quarters, SoFi originated far more personal loans ($31 billion) than student loans ($9 billion). Of course, this could be blamed on the fact that the Department of Education put a pause on student-loan payments and the accrual of interest, which just ended late last year. This situation understandably resulted in less demand from borrowers to refinance.
That's why personal loans took the lead. The worry for SoFi is that because these are unsecured debt products that typically carry higher interest rates, they are riskier to the balance sheet. If there's a recession, for example, consumers will prioritize spending on essentials, like food, gas, and rent, while possibly missing their monthly debt payments. And this could lead to higher defaults, resulting in losses for SoFi.
One could also argue that the surge in personal-loan activity points to economic troubles. In an environment where businesses are laying off workers, inflationary pressures are still present, and credit card debt is at an all-time high, it makes sense that consumers are turning to personal loans to help fill any funding gaps.
As of March 31, personal loans made up 65% of the company's total loan book. But this might start to change. Management reported that student-loan originations were up 43% year over year in Q1, while personal loans only increased by 11%. It could be some time until student loans represent a similar portion of the loan book.
For what it's worth, SoFi's competitive edge is that it caters to a more affluent demographic. "Our personal loan borrowers' weighted average income is $169,000 with a weighted average FICO score of 746," CFO Christopher Lapointe said on the Q1 2024 earnings call. "Our student loan borrowers' weighted average income is $146,000, with a weighted average FICO of 768." This could prove to be a huge benefit should the economic picture worsen.
Should you buy the stock?
I always believe it's a smart idea for investors to take the time and figure out the key risk factors facing any potential businesses they are looking to buy. How SoFi's loan book performs in an economic downturn is something important to pay close attention to. This is the case with any financial institution.
With that being said, I think the stock deserves a closer look as a potential long-term portfolio position. I have already mentioned SoFi's solid financial results. Revenue, customer, and deposit growth is still superb, even against an uncertain macro backdrop. And perhaps most important, this business is turning the corner financially, with net income set to soar in the years ahead, according to the leadership team.
What's more, SoFi shares trade at a compelling valuation. The current price-to-sales ratio of 3.1 is well below the historical average of 4.2. Even when you consider the risk that higher personal-lending activity poses, investors may want to buy the stock.
