Introduction: ETF investors often buy when the fund price declines and sell when it rises. However, a decline in the asset price does not mean the asset is correctly valued.
Even though ARKK has fallen more than 60 percent in the past year, it contains several holdings that are still overvalued, and its PE ratio is undefined because of negative overall earnings.
Empirical Analysis of Current ARKK Holdings: The ARKK fund is an actively managed fund that invests exclusively in companies that the fund manager believes will disrupt the economy. Data on the holdings of the fund was obtained from Zachs. It has 34 companies and a small amount in a fund that has government securities. Financial data on the 34 equities in the funds was obtained from CNBC. Here is the link to financial data for Tesla the fund’s largest holding.
Financial variables for the 34 ARKK holdings indicates that despite large declines in share prices most of the holdings in the ARKK fund remain overvalued.
- Only four of the 34 holdings (Tesla, Zoom, Nvidia, and Materialise), around 17 percent of the holdings of the fund, reported positive earnings per share.
The weighted average of net earnings was negative making it impossible to report a PE ratio for ARKK. Firm PE ratios are undefined for firms with negative earnings. ETF PE ratios are undefined when the denominator of the PE ratio, a weighted average of earnings per share is negative.
An alternative valuation metric used when earnings are negative is the difference between share price and earnings per share price over share price. High values of (P-E)/p correspond to high valuation measures.
A value of (P-E)/P equal to 0.98 is equivalent to a PE ratio of 50. A value of (P-E)/P greater than 1.0 is undefined due to negative earnings. The use of (P-E)/P allows for the inclusion of firms with negative earnings in comparisons of portfolio valuations. Go here for a discussion of the alternative valuation statistic.
- The value of (P-E)/P for ARKK is 1.082.
High valuation measures are acceptable when firms are investing and growing. Early investors in firms like Apple and Amazon did quite well despite years of high valuations. The ARKK holdings are not similarly situated.
- 33 of the 34 ARKK stocks experienced a decline in price over the past 52 weeks. The average stock price over the last 52 weeks was down 63.1 percent. The lower stock price makes it expensive for these firms to raise additional funds in equity markets.
- 9 of the 34 companies had an earnings per share loss that exceeded 25 percent of the stock price. The existence of larger losses relative to share price could be indicative of concerns about future liquidity.
- ARKK owns more than 5.0 percent of the shares in 16 of its holdings. These relatively high stakes could limit the ability of ARRK to reallocate and reduce exposure without exacerbating declines in stock prices.
The empirical analysis reveals several red lights on the future of ARKK including — high valuations, previous large stock price declines, existence of several holding with large losses compared to equity, and high exposure in some positions.
Discussion of ARKK holdings: The rationale behind investing in potential disruptors is the likelihood of one or more large successes leading to large returns. Some of the ARKK investments are interesting and could be considered once the tech market nears a bottom. However, ARKK has a lot of companies that are unlikely to prosper.
I looked at some of the news and analyst on the 10 largest ARKK holdings. Here is what I found.
Tesla: symbol TSLA Tesla is the largest position and ARKK’s most successful investment. Tesla has been a true disruptor. However, its valuation is high $642.3 billion more than the rest of the world’s auto industry. Tesla sold fewer than a million vehicles in 2021 compared to over 9 million by Toyota alone. Tesla makes most of its money from the sale of cars but does have some other energy streams. Tesla is the leader in electric vehicles, but Porsche may have the better high-end car and other firms are entering. At current stock prices Tesla is a better buy than ARKK but may not be a good long term buy. Even with other income streams it is difficult to justify a price on Tesla that makes a relatively small auto company more valuable than the rest of the industry. I am not currently a buyer of either the TSLA or ARKK.
Zoom: symbol ZM, Zoom did extremely well due to at-home work during the pandemic, but the pandemic growth rate is over, and the company is facing new competition from Microsoft and possibly other larger firms.
Roku: symbol ROKU, Roku attempts to make it easier and more affordable for people to watch multiple TV shows. ROKU’s top competitors are Apple, Net Flix, Amazon, and Microsoft. Stock price is falling. If you google ROKU and problems, you get several links on how to deal with technical ROKU issues. Other applications and services may be more reliable than ROKU. I have no reason to believe that ROKU will win this competition.
Unity: Unity Software, symbol U. is a software developer and may benefit from the metaverse. The company might be acquired by a larger firm. A speculator might be better off purchasing a small amount of U rather than ARKK.
Block inc., symbol SQ, is a financial services firm. Visa and Paypal appear to be better positioned than Square.
Teledoc, symbol TDOC, has several active competitors. Go here for one list. Two funds owned by Cathie Wood have invested in Teledoc. She may not be able to get out of these positions without causing a large decline. I would not buy Teledoc either by itself of through ARKK.
UI Path, symbol Path, is an artificial intelligence company that helps automate routine tasks. It has viable products but it stock price has fallen by nearly 80 percent. Path is a company that might be worth looking at once the tech sector bottoms. ARKK bought it too soon.
CRISPR, symbol CRSP and BEAM therapeutic, symbol Beam: are two gene editing companies owned by ARKK. Combined they are around 8.5 percent of ARKK holdings. Hard to understand why ARKK holds so much of these two firms and no Moderna.
Coinbase, Symbol COIN: Coinbase is a bad apple in an industry that is looking for a reason to exist. Google Coinbase and allegations and get this.
Some of the ARKK holdings deserve consideration, but ARKK is not the best way to participate in these opportunities. Interested investors should consider purchasing the better companies directly or investing in a more diversified tech fund, like VGT.
I have nothing against a fund that seeks out disruptive firms but believe ARKK is poorly designed and not an appropriate investment vehicle.
The ARKK fund did well when expectations of tech returns were high and interest rates were abnormally low. It is wrong to attribute the sinking of ARKK over the past year to higher interest rates since rates today are still below their historic medians.
The investment philosophy behind ARKK is reminiscent of the gamblers ruin problem. The gambler playing a game, or in this case several highly correlated games, with a negative expected value will eventually go broke.
The disruptor fund might put 50 percent in a small number of disruptors and 50 percent in a safe asset. The fund would take profits and invest in the safe asset in successful years and invest in bargains during downturns.
Authors Note: David Bernstein has written Financial Decisions for a Secure and Happy Life, a manifesto that will improve your life and save you tens if not hundreds of thousands of dollars.