ARKK Is Starting To Sink Into Value Territory

ARKK Is Starting To Sink Into Value Territory

Just_Super/E+ via Getty Images Thesis

ARK Innovation ETF ( ARKK ) is becoming undervalued, secondary to the classic overcorrection phenomenon that occurs to an equity based security, after a period of overvaluation. ARKK has fallen out of favor with traders who’ve anticipated the market rotation from growth to value as inflation, and the Federal Reserve’s response to such in the form of projected rate hikes and quantitative tightening, has become a concern. Further traders who used ARKK as a pandemic related safe haven seem to be continuing to abandon that position as the worst of the pandemic’s ability to create uncertainty seems to be behind us.

The market is often inefficient, and too much negative focus on ARK’s pandemic related stocks, such as Roku Inc. ( ROKU ) and Teledoc Health Inc. ( TDOC ), as well as their currently unprofitable smaller holdings, who’ve yet to prove themselves in a higher interest rate environment, is overshaddowing the strong projected earnings growth of their profitable holdings, as well as the strong revenue growth of the majority of the fund’s holdings.

Based on my conservative sum of parts calculations, which are a function of projected earnings growth and eventual reversions to fair values of the individual holdings, Cathie Wood seems optimistic when she said in late December of 2021 that ARKK could see 30-40% CAGR long term price appreciation (when the fund was sitting a little below $100 per share) – but there is still room for considerable price appreciation at this point. Strategy

Those wishing to invest long in ARKK should take advantage of the current Russian/Ukraine related volatility to start positions well underneath my calculated fair value, buying incrementally into the negative momentum as the likely overcorrection unfolds.

ARKK’s financial strength, based on my calculated weighted average financial strength of its holdings, is significantly weaker than the more famous large cap growth companies like Amazon ( AMZN ) or Meta Inc. ( FB ), but is comparable to many market stalwarts, like International Business Machines ( IBM ) and Prudential ( PRU ). Thus it is investable, but one should not YOLO a significant portion of their portfolio into it, regardless of my projected CAGR and price target, for the purposes of managing risk.

I personally started a position last week, to which I will add up to 0.5% of my portfolio over 2022, if Russia or the Fed gives me that chance. But because of its weaker financial position I recommend staying safe, and striving to buy at or under 85% of price to fair value, to garner a margin of safety. The Classic Overcorrection From Overvaluation to Undervaluation

Altria ( MO ) is a good example of the overcorrection phenomenon, since its projected future earnings are relatively easy for analysts to predict. Analysts are correct the majority of the time regarding future earnings calls, so we can see when traders are being overly pessimistic on a price and earnings generated time series: FAST Graphs on Twitter We can see on the FAST Graph that MO was overvalued in the 2014 to 2017 range, then ultimately reverted back to its historical average PE of 15.4 and subsequently fell further into undervaluation territory. On the day this graph was captured, MO was at $40.12 and its fair value, based on this average, was around $64.

Traders were discounting the stock relative to analysts and historical averages for reasons not novel to the general risk profile of the company: 1) regulatory risk; 2) declining cigarette volumes, even though the company has decades left of pricing power to override this concern; and 3) concern about poor execution of growth of reduced risk product revenue. Momentum turned a justified correction into an unjustified one.

The same phenomenon has started to happen to ARKK, which after its massive sell off, is holding mostly undervalued companies with a handful of still grossly overvalued ones, that are upwardly skewing its weighted average price to fair value ratio, making it seem as though it’s still vulnerable to permanent and significant downside.

My calculated price to fair value (P/FV) for the fund is based on a weighted average, with the weighting being a function of each individual holding’s capital weighting in the fund. Tesla ( TSLA ) therefore has a lot more influence on the final P/FV than Roblox ( RBLX ) does. Proprietary Equation Fortunately Morningstar covers most of the heavily weighted holdings in ARKK, and I was able to incorporate their published fair values for these companies into my calculation. Morningstar is […]

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