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1 Overvalued Buffett Stock I Wont Touch

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This is a fantastic Warren-Buffett-backed company. But the shares are extremely expensive.

Stocks with high growth potential often come with a matching high premium. These are often justified based on the potential for gains. Many investors are willing to pay for stocks that can bring rewards, but growth stocks also often come with risk.

Investors look to several possible valuation metrics to assess a company's risk versus its potential reward. Many of them take net income into account, such as the price-to-earnings (PE) ratio or the price-to-earnings growth (PEG) ratio. If a company doesn't have any income, which isn't unusual for high-growth companies, investors might look at the price-to-sales (PS) ratio or enterprise value (EV) divided by earnings before interest, taxes, deprecation, and amortization (EBITDA).

One stock that's been showing high growth and has tremendous promise, but a super-high valuation, is Nu Holdings (NU -5.46%). It's a very enticing stock, but at its current valuation, I can't justify buying it -- yet.

Image source: Getty Images.

A bold new way to bank in Brazil

Nu Holdings is a Brazil-based financial services company that seeks to empower individuals through its customer-centric and easy-to-use digital platform. It seeks to help customers cut through the heavy red tape that has historically marked the Brazilian banking system, which has been dominated by five banks.

It has a $1 trillion market opportunity, targeting the 650 million people in Latin America, focusing on a population of 'underbanked, unsatisfied, or completely unbanked' people. It's currently serving Brazil, Mexico, and Colombia, but plans to expand to more Latin American countries.

It offers services in what it calls the 'five seasons,' which are spending (credit cards), saving (banking), investing, borrowing (loans), and protecting (insurance). It has proven to be a popular concept that is achieving its goal of disrupting the Brazilian banking system. About a third of the total Brazilian population over age 15 is already on it, and it was voted the No. 1 most loved brand in Brazil by eCGlobal in 2021.

Between 80% and 90% of customers have come on board organically since inception from word of mouth. That's a unique feature that most companies can't boast. It has a net promotor score of 90 out of 100, which is extremely high and rare.

Nu is backed by a group of large and well-known funding firms, including Warren Buffett's Berkshire Hathaway, which joined in with a $500 million investment last year.

Astronomical growth 

By all accounts, the 2021 fourth quarter was a smashing success. Nu added 5.8 million customers for a total of 53.9 million, 62% more than last year. In Mexico, customer count increased more than 1,200% to 1.4 million. Revenue increased 224% year over year to $636 million, and average monthly revenue per active customer rose 5.6% year over year. Deposits rose 86% from a year earlier to $9.7 billion, with an interest-earning portfolio of $2 billion, up 344%.

Nu started with its credit card business as an easy way to offer better products for frustrated customers, and it's building from there. This strategy gives it access to lots of data and a foundation on which to expand. It's also improving its gross margin, as revenue per customer widens over time as customers use more products and increase engagement. For example, from March 20 to Sept. 21, the ratio of daily actives to monthly actives increased from 35% to 48%

Due to its popularity, it's also been able to demonstrate impressive growth with low customer acquisition costs. Contribution margin (revenue from credit card, loan, and NuAccounts minus variable expenses associated with revenue) is expanding, as the company demonstrates nicely in this chart:

Cumulative Contribution Margin Less Customer Acquisition Cost

Chart source: Nu Holdings. Per Acquired Customer (Brazil), US$FX Neutral, Q2 2018 – Q3 2021

Still too rich for my taste

Everything I've written up until now makes this sound like a dream stock. The company has a disruptive model that is making a difference, giving it an edge over legacy providers. Customer acquisition costs are low compared to potential lifetime value. Customers are over the moon. The opportunity is enormous. Even Buffett is on board.

But the valuation is very high. The company isn't profitable at this stage of the game, and it has no EBITDA, so we'll go with price-to-sales ratio, which was slashed about in half after the fourth-quarter earnings were reported, from 41 to 21. That brings it closer in terms of a competitive valuation, but it's still pricey. For comparison, a typical bank stock typically trades for less than 10 times earnings, not sales. Block, a more comparable high-growth stock that sometimes posts profits, trades at 3.6 times sales, and MecadoLibre, a Latin American fintech company that is usually profitable, trades at eight times sales.

Profitability doesn't look to be on the horizon anytime soon for Nu. The average Wall Street consensus is a loss per share in 2022. Nu stock is down about 15% since its initial public offering in December from its $9 IPO price.

Nu is a great company to keep on your watch list, but I'll be sitting this one out until the valuation comes down more.


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