ARKW: And Then There Were None

Summary

  • A mysterious force is killing ARK Next Generation Internet Fund's growth stocks.
  • We go over our outlook for ARKW's holdings and tell you why these growth stocks are being killed.
  • We also tell you where we see this bottoming.
  • Looking for option income ideas that focus on capital preservation? I offer this and much more at my exclusive investing ideas service, Conservative Income Portfolio. Learn More »

Agatha Christie"s Books

Jelena990/iStock Editorial via Getty Images

A mysterious force is killing ARK Next Generation Internet Fund's (NYSEARCA:ARKW) growth stocks, one by one and it reads like the most famous Agatha Christie Novel. Six months back we identified the condition as Only 3 Generals Of Bubble Mania Left To Fall.

We suggested that the three that were left standing, Tesla Inc. (TSLA), Shopify (SHOP) and Grayscale Bitcoin Trust (OTC:GBTC), were even more ridiculously valued than anything else in the fund and were due to meet the same fate. How have these three top holdings done since then?

Tesla, Shopify, and Grayscale Bitcoin Trust: price % change
Data by YCharts

They joined the rest of their brethren and it resulted in ARKW dropping 60% in the last six months. We go over our outlook for ARKW's holdings and where we see this bottoming.

Top Holdings

There has been a lot of change in the order of the top holdings for ARKW with Roku Inc. (ROKU) vaulting to the top from the seventh position in December. Twitter Inc. (TWTR) which was one of the top holdings has been relegated to a footnote. This possibly comes due to profit taking with the drama surrounding the company.

ARKW top holdings

Top Holdings (ARKW)

Some of the other names gracing the bottom have been reduced after they have taken massive hits.

Peloton price % change
Data by YCharts

Palantir Technologies Inc. (PLTR) which was there the last time we looked at the fund, has disappeared as well. The fund has kept things concentrated with the 18 top holdings making up 85% of the fund.

Valuations

We looked at the top 18 holdings through a variety of metrics to assess whether they still have potential for a rebound. On a GAAP profitability test, which was basically a "yes" or a "no", shockingly, only two met the criteria.

ARKW GAAP profitability

GAAP Profitability (ARKW & Author)

GBTC of course holds only Bitcoin (BTC-USD) and so traditional GAAP metrics don't apply. As we have said before, we view all the cryptocurrencies to be worthless PONZI schemes, so everyone should know what we think of that holding. That theory got some more validation with the StableCoin known as TERRA, meeting its strong support at $0.00.

Terra to USD chart

TERRA (COIN Market Cap)

Who could have even dreamed that a cryptocurrency offering 20% "risk-free" interest rate could go to zero?

Getting back to the rest, not only did most not meet GAAP profitability, but almost all of them also failed to meet the Non-GAAP profitability benchmark. One big component for the Non-GAAP numbers transition is the add back of stock-based compensation. Below we show the stock-based component for some of these holdings.

Twili, Shopify, Teladoc, Unity and Roku: stock based compensation
Data by YCharts

These are truly massive numbers for these companies. Twilio Inc. (TWLO) is paying about 20% of current revenues in stock-based compensation. They are not expected to be profitable, even if you add back this massive employee salary by another name. These numbers are all accelerating upwards. SHOP's stock-based compensation is about to hit $7/share or $800 million in 2022.

$800 million is again close to 20% of trailing 12-month revenues. SHOP only crossed $800 million of total revenues less than four years back.

Shopify revenue
Data by YCharts

These large amounts are not even being counted in the equation and the bulk of these cannot make the positive P/E ratio cutoff.

Outlook

It is easy to slap 30%, 40%, 50% growth rates over 10 years and then come up with a reasonable valuation. Most of these claims are extremely outlandish and have zero basis in reality. Even in cases where 20% growth rates are feasible, they tend to pause during bad economic conditions. In 2000-2002 which featured one of the mildest recessions, Amazon Inc. (AMZN) was the only stand out in the group, with revenue growth slowing to 2% at one point. Apple Inc. (AAPL), Intel Corp (INTC), Nvidia (NVDA) and Adobe Inc. (ADBE), all had significant revenue declines at one point or another.

Amazon.com, Apple, Intel, NVIDA, and Adobe: revenue
Data by YCharts

So you will likely run into that one or two years from now, and none of these companies are even remotely priced for that today.

Verdict

That mysterious killer of these growth stocks is none other than Valuation. Every stock at some point moves from overvalued to undervalued and the further above the mean you go, the further below it you fall. As for where this all ultimately goes, we are sticking with the analogy of ARKW to Jacob's Internet Fund (JAMFX). The fund was the go-to bubble investment in the dotcom bust and bottomed close to 96%.

Jacob internet Inv total return
Data by YCharts

What is hard to visualize in that chart is that there were many, many bounces and rallies. This table below does a great job of showing how often the NASDAQ bounced and how the green days almost kept up with the red.

22v technical analysis

- (Seth Golden (Twitter))

So on the way down, expect a slope of hope. Keep in mind also that technology (hardware and software) and consumer discretionary have a really a hard time performing when inflation rises. The data below from the 70's shows just how badly those categories did versus cumulative inflation (red line).

total returns 1970-1981

Total Returns 1970-1981 (Prof. Ken French at Dartmouth)

So ARKW has a long, long way down until realistic valuations set in. We need to fall another 80% from here to get to the overall 96% drop. Tactically, though, shorting this low below its 200 and 50-day moving averages is suicide for the trader. Yes, it may work, but the risk reward is not well set up. Hence we rate this as neutral/hold for now and would look on the short side near the 50-day moving average.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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