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Cathie Wood’s ARK Innovation ETF looks like the Nasdaq in 2000, only more overvalued

August 19, 2021, 12:00 AM UTC

On June 15, Michael Burry warned in a blog post that the raging bull market had created “the greatest speculative bubble of all time.” Burry’s an expert at calling crazes en route to disaster. His billion-dollar bet against the housing market during the 2006 frenzy was immortalized in Michael Lewis’s book The Big Short and the 2015 movie by the same name. Hence, it’s instructive that Burry chose to profit from what he sees as the latest episode of markets-gone-wild by shorting Cathie Wood’s highly publicized flagship ARK Innovation fund that’s been one of the hottest of all ETFs. Over the past half-decade, ARK Innovation’s price has multiplied fivefold to $117 as of Aug. 18, waxing the S&P’s big gains by more than two to one.

In early 2000, the Nasdaq’s price/earnings ratio soared to over 100 as the index reached 5000, boosted by hot Internet and communications stocks. By the fall of 2002, the Nasdaq had shed three-quarters of its value. By calling today’s levels the ultimate in speculative excesses, Burry is inviting a comparison to that crash. He’s apparently targeted the ARK Innovation ETF as a hotbed of overvaluation. So let’s examine the ARK portfolio and see if the prices of its stocks, versus their earnings, are signaling extreme danger, as the Burry short suggests.

Relatively few of ARK’s holdings make money

For this analysis, we’ll look at the fund as if it were one big company. We’ll call it ARK to the Future, since for Wood, it’s a vehicle for capturing disruptive, world-changing technologies. As of Aug. 17, the ETF holds 48 stocks with a total value of $25.75 billion, so let’s give ARK to the Future the identical market cap. I then calculated the percentage of each company’s stock that the fund owns, and its pro rata share of the net GAAP earnings for all of them. For example, ARK’s largest investment is in Tesla. It owns $2.257 billion in the EV-maker’s shares or 0.3%. Since Tesla’s earned $1.69 billion over the past four quarters, ARK’s slice of its profits is $5.8 million (0.3% of $1.69 billion).

ARK to the Future’s largest “earner” is Coinbase. It owns 5.4% of the crypto exchange; so its share of Coinbase’s $3.6 billion in annualized profits is $58 million. The second biggest contributor is Crispr Therapeutics, a Swiss-American biotech where ARK’s 2.5%, $594 million stake translates into $30 million a year in net earnings. But ARK is extremely short on moneymakers. It’s especially worrisome that Coinbase is providing the largest single portion of the fund’s profits. The fledgling exchange is enjoying gigantic profitability since trading margins on cryptocurrencies are many multiples the numbers for stocks and bonds. But Coinbase’s returns will shrink as more and more rivals enter the market, a trend that’s already underway.

Of the 41 companies that represent 98% of dollars invested, only 13 posted positive net profits over the past four quarters. That group earned a total of $161 million. The plus-contingent comprises some of the most expensive big names in tech. For the 13, the median price/earnings ratio is a lofty 98. Tesla is providing a dollar in earnings for every $351 in market cap, while the multiples for Zoom, Twitter, and Square respectively are 119, 133, and 235.

ARK’s portfolio is dominated by money-losers, big-time

The other 28 holdings posted losses over the past four quarters. ARK’s second largest investment is in Teladoc, the virtual health care platform. ARK’s pro rata share of Teladoc’s losses is $41 million. Sea Ltd., a Singapore electronic gaming enterprise, posted deficits of $1.76 billion over the past four quarters; ARK’s proportion is $25 million. ARK has a superheavy dose of health care technology. Most of its holdings are young biotech names. That category typically loses money in the early years while new, potentially groundbreaking therapies are still in development. But most of those investments fail to pay off, and ARK holds an outsize share of those names. Virtually all of its biotechs are losing money, often big money. ARK’s portion of the losses is $17 million in Invitae, $29 million in Beam Therapeutics, and $32 million in Exact Sciences.

All told, the ARK investments are booking losses

So how many dollars in earnings are the ARK investors getting for their $25.75 billion investment? ARK’s stake in the 28 in-the-red holdings lost an annualized total of $330 million. That swamps the $161 million contribution from the 13 “earners.” Overall, ARK Innovation’s investments are losing $169 million a year.

From these depths, the fund must sprint to deliver decent returns. Obviously, Burry believes it can’t get there, and he’s probably correct. By buying into the ETF, investors are embracing an ultra-risky, highly expensive portfolio. They’d be expecting annual returns of at least 10% over the next decade. To deliver 10% a year, the fund’s current market cap would need to jump from today’s $25.75 billion to $68 billion by the late summer of 2031. At a premium P/E of 30, the ARK holdings would be generating GAAP net earnings of $2.2 billion.

We can’t calculate the growth rate, since ARK Innovation is starting well below zero. Based on ARK’s percentage ownership, its stocks would need to soar out of the $169 million hole and add almost $2.4 billion in profits. To get an idea of how difficult that is, the 13 holdings that do make money now have a combined investment in the portfolio of $10 billion and generate earnings of just $161 million, for a heady P/E of 62. To make that 10% hurdle, ARK’s share of their earnings would need to jump to $887 million, an almost sixfold leap.

It’s as if the portfolio were designed to combine the most expensive of the relatively established stocks (Tesla, Zoom, Shopify) with a war wagon of biotechs that are bleeding cash. What a blend! This portfolio that Wood claims now stands at the doorway of revolutionary technologies is also at the far frontier of danger. The overall, tech-dominated Nasdaq of today isn’t nearly as overvalued as the Nasdaq of 2000. But the ARK fund that cherry-picked the names on the outer limits of valuation and cast its lot with biotech startups whose drugs may never come to market could be just as outrageously overpriced.

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