ARKK: The Bubble Has Already Been Burst – Don’t Miss The Bottom (NYSEARCA:ARKK)

Investment Thesis

ARK Innovation ETF (NYSEARCA:ARKK) has been hammered by critics and the market over the past year. After notching a phenomenal 2020, Cathie Wood’s flagship fund lost 61% from its 2021 highs to its recent March bottom. However, despite seeing fund outflows for most of 2021, ARKK dip buyers have returned in force in February and March. As such, its inflows nearly reached $1B recently.

It was certainly easy to bash the “fallacies” of ARK’s investing approach. Many of these companies are on the “high-growth” spectrum. Therefore, they have not been calibrated for profitability, as they are still focused on penetrating their large market opportunities.

Notably, we also noticed that many of them have been buffeted significantly. As such, their valuations have also undergone substantial compressions.

Furthermore, many of its underlying stocks also seemed to have bottomed out with the broader Invesco QQQ ETF (QQQ). As such, the time to short ARKK has come and gone. Yes, the fund’s performance was pulled forward by the pandemic and the Fed’s generous liquidity. But, we think that the bubble has already been burst.

Therefore, we believe investors who have been biding their time to add ARKK can consider capitalizing on its recent bottom.

Underlying Stocks Have Been Hammered

Name of company	Weight %
Tesla (TSLA)	9.51%
Coinbase (COIN)	6.64%
Roku (ROKU)	6.64%
Teladoc (TDOC)	6.62%
Zoom (ZM)	6.25%

ARKK Top 5 holdings as of 30 Mar’22. Source: ARK, Author

We think it’s reasonable to argue that ARKK’s top holdings, ex-Tesla, have already been hammered over the past year.

Tesla (TSLA) stock has continued to maintain its pinnacle position in the ETF, given its leadership position in the EV market. We also highlighted TSLA’s stock (Buy rating) in January and March, emphasizing its production and supply chain leadership. In addition, Bloomberg reported on Wednesday that Tesla had already inked a long-term nickel deal with mining giant Vale S.A. (VALE). It added (edited):

The invasion of Ukraine has added to agita among electric-vehicle makers over the supply of nickel. But Tesla had already been scouring the globe for the metal, signing pacts with several nickel suppliers since 2021. That includes a multi-year supply deal with mining giant Vale SA. The agreement, which hasn’t been announced, covers nickel from Canada. – Bloomberg

TSLA stock has regained its upward momentum, moving well past its February/March bottom. However, the same can’t be said of ARKK’s other key holdings. Nonetheless, COIN stock has recovered remarkably. We discussed in an earlier article highlighting that we were confident of it hitting our price target of $200. While COIN remains a speculative play for us, we consider it a proxy for cryptocurrencies. Furthermore, the crypto leader Bitcoin has also been in a risk-on mode, as it closed above its January highs recently. We also discussed in a February article imploring Bitcoin investors to capitalize on its recent weakness to load up.

Consequently, astute investors have been trying to pick the bottom in these beaten-down plays and support their prices. Notably, the market’s mood has been so pessimistic that it even reached a perfect storm recently in Chinese tech stocks. We highlighted why investors have gotten so gloomy that they have gone into capitulation mode.

Why Are These Companies Focusing On Revenue Growth?

Even with the massive collapse in their valuations, ARKK’s underlying stocks are still traded at a premium, as seen above. Furthermore, some of its stocks, like Exact Sciences (EXAS) and Twilio (TWLO), have negative FCF yields.

Consequently, it should be evident that these companies have not been optimized for profitability yet. ARKK investors must remember that ARK Invest has consistently emphasized at least a five-year holding period with its approach. Therefore, investors must adjust the exposure to their portfolios accordingly. Investors would be remiss to fill their portfolios entirely with disruptive tech stocks. Portfolio allocation discipline must be adhered to. For high-growth/speculative stocks that are still unprofitable, remember: “If it works out, a little is all you need. If it doesn’t, then a little is all you want.”

Notably, it’s critical to remember that these companies are still in the early innings of exploiting their massive TAM. Unity CFO Luis Visoso emphasized (edited):

Well, of the three drivers of shareholder value creation, that is revenue growth, margin expansion, and free cash flow efficiency, the one that will make the biggest difference for us, at this particular point in time, is revenue growth. Just think about it, we just crossed $1.1B, and we operate in a $45B market. So we are at about 2% of the market. Now that doesn’t mean we’re not going to pay attention to margins and free cash flow, we definitely will. (Unity’s FQ4’21 earnings call)

Notably, Unity has provided guidance toward FCF profitability. In addition, Twilio has also updated that it would be focusing on gaining leverage to achieve profitability on adjusted terms.

Is ARKK A Buy, Sell, Or Hold?

ARKK is a Buy. We consider an investment in ARKK with a minimum five-year horizon, nothing less. If you cannot accept volatility, you should stay away from ARKK. Disruptive innovation-based investing is not for everyone, and we understand that.

Furthermore, we believe investors have been fed so much pessimism that they missed the February/March bottom. In fact, the market had already shown evident signs of bottoming in late February. We also highlighted in our service for our members on February 28 (edited):

Our market conditions composite indicator has also improved. The bullish score is now 61.3%. Moreover, the long-term score improved markedly to 96.4%. Bearish conditions remain very low at just 5%. LT bearish is 0%. Therefore, these are excellent conditions for investing. Of course, if we want the bullish score to go to 75% and above, we have to enter a bear market first, as we mentioned. That will be the “perfect” scenario for adding aggressively. Remember, “no pain, no gain.” Otherwise, the current climate is conducive enough for us to be satisfied to continue our buying cadence. (Ultimate Growth Investing 28 February 2022 Daily Market Analysis)

So what did the QQQ do in March? It went momentarily into a bear market before staging a tremendous recovery that blindsided many bearish investors.

Furthermore, we also wanted to share an analysis of why the Fed’s rate hikes may not necessarily be punitive to tech stocks like those in ARKK. 22VResearch articulated (edited):

Rate hike expectations keep marching higher, leading to slower economic growth. As that happens growth stocks will benefit. Also, more economically-sensitive stocks often perform poorly, while investors pile into fast-growing innovators found in the technology sector.

And when economic demand slows, usually inflation ultimately does the same, which caps any increases in long-dated bond yields. Lower bond yields make future profits more valuable, and many growth and tech stocks are valued on the basis that they’ll churn out sizable profits many years in the future. – Barron’s

Therefore, we are confident that the bubble in ARKK has already been burst. The market has gotten overly pessimistic that ARKK will go to “zero.” And that’s precisely what ARKK investors needed to stage the bear trap for these bearish bets. Observant investors have already started to buy the dips in ARKK in February and March. So, it’s time you join in while the valuations remain depressed.