Buy Now, Pay Later company Affirm (AFRM -0.82%) is one of the more hotly debated stocks on Wall Street. How can investors trust a business seemingly losing money while competing in a new and growing (but crowded) industry?
Yet, the stock has risen like a phoenix from the fire, surging over 150% these past 12 months. Is Wall Street simply being irrational, or is there something to this? I decided to dig into the business to uncover why Affirm's long-term prospects aren't just promising -- they signal that investors could have a perennial market-beater on their hands.
Here is what you need to know.
Simple business with complex financials
The Buy Now, Pay Later concept is simple. People can take out short-duration loans at the point of sale, with terms as short as four weeks and as long as 36 months. The critical difference between Buy Now, Pay Later and credit cards is that a credit card represents a credit line, an ongoing tally of a total borrowed amount. Buy Now, Pay Later loans are individually originated for each purchase.
The importance of this distinction can't be overstated. It's a game-changing idea.
Originating loans by item unlocks more flexibility with financing and gives the lender (Affirm) product-level data rather than simply a transaction value and store, as you see on a credit card statement. Affirm differentiates itself in that it doesn't charge any fees, including late fees. It earns revenue from a combination of interest-bearing loans and merchant fees.
The complicated part of Affirm's business is that multiple revenue streams are constantly pouring in.
Source: Affirm FY2024 Q3 earnings.
Remember this equation: Affirm's true revenue is its total revenue minus its funding costs (it must borrow to lend all this money). This revenue increases as Affirm grows, eventually lifting the business to profitability. Affirm's GAAP operating losses were $161 million in the third quarter of fiscal year 2024, but that number is shrinking quarterly. That's an encouraging trend.
Affirm has $2.1 billion in total liquidity, split between cash and equivalent securities. Knowing that, it's clear that Affirm can comfortably fund its business as it grows and losses slowly shrink. This company is not a money pit that's due to need new capital anytime soon. That means investors can stay patient while Affirm invests in growth and taking market share.
The enormous market opportunity
Buy Now, Pay Later has become extremely popular with younger people like millennials and Gen Z. According to a late 2023 survey by eMarketer, over a third of this demographic is already using Buy Now, Pay Later services. Grand View Research estimates that the Buy Now, Pay Later industry will grow in the U.S. by over 24% annually through 2030.
Affirm's advantage over competitors is the distribution via leading U.S. merchants. Affirm works with Amazon, Shopify, Walmart, and Target. Its merchant network is 292,000 strong and grew 19% year over year this quarter.
CEO Max Levchin has repeatedly stated that Affirm competes with not necessarily other Buy Now, Pay Later companies but the traditional credit card. That should open one's eyes to the magnitude of Affirm's long-term addressable market. Today, there is over $1.1 trillion in outstanding U.S. credit card debt.
U.S. Credit Card Debt data by YCharts
Affirm's total transaction value was just $6.3 billion this past quarter. There is a tremendous long-term opportunity if young consumers gravitate to Buy Now, Pay Later solutions over credit cards as they mature. It's something to watch and could be vital to fueling sustained growth at Affirm over the coming years.
Is the stock a buy today?
Valuing the stock can be difficult because Affirm isn't profitable yet. If you compare Affirm's revenue to its enterprise value, it's clear that the stock is no longer in "bubble territory" like it was in mid-2021. Revenue also grew 51% year over year this past quarter, so valuation will quickly compress if the business keeps up this pace.
Can it? I think so. Not only is Buy Now, Pay Later growing, but Affirm has seemingly struck gold with its Affirm Card, which just passed 1 million users. This card enables people to use Affirm at the point of sale in physical stores and has dramatically improved customer activity on Affirm's platform. It's something to watch moving forward.
AFRM EV to Revenues (Forward) data by YCharts
Affirm is not a "buy now, get rich quick" stock. Shares could remain especially volatile until the business turns a GAAP profit, which would likely win some confidence from Wall Street. But there's no denying the long-term potential, and Affirm's hot performance gives long-term investors plenty to sink their teeth into.
