ByJim Pearce • May 10, 2024 • Stocks to Watch
In September 2022, I asked “Is it Time to Start Boarding the ARKK?” At that time, the ARK Innovation ETF (ARKK) managed by Cathie Wood was trading near $40 after cresting above $125 just ten months prior.
The reason for ARKK’s big drop was a huge markdown in tech stocks after the Federal Reserve began raising interest rates two years ago. Those companies are primarily valued on future earnings, which are discounted at a higher rate when interest rates go up.
Although the Fed has not cut interest rates, the expectation that it will do so this year sparked a rally in tech stocks. At the end of last year, ARKK soared above $54 less than six weeks after trading below $40.
But since then, ARKK has faded along with the odds of a Fed rate cut anytime soon. It opened this week near $46, exactly where it was five years ago.
Shortly after the outbreak of the coronavirus pandemic four years ago, ARKK skyrocketed as the Fed aggressively cut interest rates to stimulate the economy. But the “COVID bump” is over, and ARKK is once again mired in the same trading range that it occupied before the pandemic.
Over the same span, the S&P 500 Index is up 80%. The NASDAQ Composite Index, which consists primarily of tech stocks, has doubled in value.
That degree of underperformance begs the question, is there something fundamentally wrong with the way ARKK is managed?
Balloons and Ankle Weights
The explanation most often given for ARKK’s inconsistent performance is electric vehicle (EV) manufacturer Tesla (NSDQ: TSLA). Tesla is the fund’s largest holding at roughly 12% of total assets.
However, that excuse does not hold up under scrutiny. Despite being far below its all-time high share price in 2021, TSLA has gained 160% over the past five years.
However, Tesla has lost ground this year. A few years ago, Tesla was the balloon that sent ARKK soaring. Now, it has become an ankle weight holding it down.
Six months ago, the same could be said for the fund’s second largest holding, cryptocurrency facilitator Coinbase Global (NSDQ: COIN). After peaking near $350 in November 2021, COIN was trading below $80 last October.
However, COIN has rallied along with the overall stock market. It is now back above $200 as cryptocurrencies such as Bitcoin (BTC) have soared this year.
In other words, the reason for ARKK’s long-term underperformance is not Tesla, and the reason for its short-term underperformance is not Coinbase.
That being the case, it must be the fund’s other holdings which comprise approximately 80% of its total assets that are the underlying problem. Simply put, they are not appreciating along with the overall stock market.
I think I know why.
Two weeks ago, ARKK manager Cathie Wood revealed that the fund recently bought more than 45,000 shares of Palantir Technologies (NYSE: PLTR). According to Palantir, it “builds and deploys software platforms for the intelligence community to assist in counterterrorism investigations and operations.”
That is a noble cause that is in high demand these days. However, that does not necessarily make it a good investment.
Profits Matter
I was surprised to see that ARKK is loading up on Palantir. Last November, I recommended a put option trade in Palantir to my Mayhem Trader readers (a put option goes up in value when the price of the underlying security goes down).
I noted then, “at a current share price near $21, PLTR is valued at more than 70 times forward earnings and 22 times sales.” I further observed, “That’s a heady valuation for a company that is only marginally profitable.”
Six weeks later, I closed out that trade after our put option doubled in value. During that span, PLTR fell from $21 to $17. The following month it jumped above $25 after reporting better than expected fiscal 2023 Q4 results.
Apparently, that is the approximate price ARKK paid for Palantir. Unfortunately for ARKK’s shareholders, PLTR dropped below $22 last week after the company released its fiscal 2024 Q1 results.
Most of those numbers were good and Palantir raised its revenue guidance for this year, but Wall Street wanted more than that. All that revenue is not translating into profits.
Therein lies the problem with the ARK Innovation ETF. Most of the companies this fund owns are good at increasing revenue but fall short when it comes to making money.
My advice to Cathie Wood is to start finding companies that are both innovative AND profitable. That is what Berkshire Hathaway (NYSE: BRK-A) chairman Warren Buffett does and explains why his shareholders have doubled their money over the past five years.
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