The Case Against Coinbase Stock At The Lows

The second is that COIN stock now looks absurdly cheap. Based on GAAP (Generally Accepted Accounting Principles) accounting, over the last six months, Coinbase has generated more than $10 per share in earnings. The stock currently trades at $65, suggesting a price-to-earnings multiple of just over 6x. That's one of the cheapest P/E multiples in the entire market.

The problem for COIN, however, is that neither fact is actually a reason to buy the stock. Indeed, looking closer, there are reasons to stay away from the shares entirely.

There's a hugely important point to make about COIN stock, and indeed the many other growth stocks like it: It does not matter how far a stock has fallen (or, for that matter, how far it has risen).

Focusing on past prices is a classic error known as 'anchoring bias', in which investors anchor on to a past price as somehow more correct than the current price. That is not guaranteed to be the case. Indeed, it's not likely to be the case. Current prices, of course, include more and newer information than past prices.

It doesn't matter that Coinbase once was valued at more than $60 billion. What matters, fundamentally speaking, is that the company now is still valued at over $12 billion.

Looking forward—and investing is always about looking forward—Coinbase needs to generate the earnings and free cash flow to justify that valuation. Where the company and the stock were valued in the past have no bearing on its ability on its fundamental performance in the future.

The danger of anchoring bias is a painful lesson that investors learned in 2000-2001 and 2007-2008, in particular. Given that so many low-quality companies saw such astronomical valuations in 2021, many investors unfortunately are likely to relearn that lesson in 2022.

Again, investors need to look forward, not backward. That applies not just to COIN's stock price, but also to its earnings.

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Last year, unquestionably, was a banner year for the cryptocurrency exchange. A hot crypto market, which saw individual and institutional investors rush the market, benefited the company enormously.

Indeed, Coinbase's results for 2021 almost seem unbelievable. Total revenue increased more than 500% year-over-year. Net income attributable to common stockholders rose incredibly by 28 times.

The problem for COIN stock, however, and the reason why a 6x trailing 12-month P/E multiple doesn't make the stock cheap, is that 2021 clearly was an outlier. For full-year 2022, per the company's first quarter report, Coinbase, in fact, expects a rather large loss.

Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) in 2021 was over $4 billion. In 2022, Coinbase expects a loss of roughly $500 million, which, in turn, suggests a net loss (even on an adjusted basis) nearing $700 million.

Obviously, weakness in the crypto market is a factor. The collapse of the Terra stablecoin certainly won't help sentiment in the space.

But Coinbase has a longer-term problem as well: its take rate. The take rate is the percentage of volume Coinbase records as revenue and is defined as revenue divided by trading volume—essentially, its fee for transactions. In Q1 2021, Coinbase's take rate was 0.477%. A year later, the figure was 0.455%.

That doesn't sound like a big decline. But in the context of hundreds of billions of dollars in quarterly volume, it is. It's a nearly 5% compression in the course of just one year. And that lost revenue hurts margins. Nearly, all of those dollars would have turned straight into pre-tax profit.

The trend of a lower take rate is likely to continue. Competition from other exchanges, as well as Robinhood (NASDAQ:HOOD), Block (NYSE:SQ) and other platforms, will lead to lower fees and a lower take rate. The growth of institutional investors over time—the lion's share of which get volume-based discounts—will add further pressure on the figure.

Coinbase needs reasonably consistent and reasonably high volume growth simply to offset the take rate problem. It needs even more growth for the company to return to profitability from the expected 2022 losses. It's difficult to argue that such a profile supports a $12 billion valuation, let alone upside from that level.

To be fair, all is not lost for Coinbase. And there's certainly an argument for the stock to rise from here. Wall Street seems to be making that argument: the average price target at the moment sits incredibly at $177, nearly 200% upside from the current COIN stock price.

Personally, I'm exceptionally skeptical of that target. But, to be honest, I'm probably more skeptical toward crypto than most. If crypto indeed becomes a legitimate, relatively stable asset class, and institutions stay invested in the space, Coinbase results and Coinbase stock both can bounce back.

In that scenario, performance isn't nearly as good as 2021—but also isn't nearly as bad as 2022. Coinbase returns to profitability, starts generating real cash flow (perhaps $1 billion-plus, in between the results of this year and last), and the stock gains nicely over time.

There is a legitimate argument for that kind of outlook. But what's important about that bull case is, unlike looking at the 80% decline since November, or a trailing P/E multiple, it's a forward-looking argument. It's not an argument I personally would buy. But, at the very least, it's the only type of argument others can or should buy.

As of this writing, Vince Martin has no positions in any securities mentioned.

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Written By: Vincent Martin