During its brief history as a publicly traded company, the cryptocurrency exchange Global Coinbase (NASDAQ: COIN) exceeded expectations by an incredible margin. For example, analysts believed the company would report a profit of $ 2.33 per share in the second quarter of 2021. Coinbase actually made a profit of $ 6.42, beating estimates by 176%.
But according to TipRanks, analysts are extremely divided over Coinbase stock, which is trading at around $ 260 per share at the time of writing. Price targets are as high as $ 500 and as low as $ 220. Obviously, Wall Street doesn’t know what to think of this company.
Sometimes a confusion like this presents an opportunity for those who can see it clearly. It’s not clear if this applies to Coinbase stock, but it looks like the rise is underestimated here.
Develop the core business
Coinbase has two main groups of customers: institutional investors like hedge funds and retail investors like you and me. The company generated 88% of its total revenue in the second quarter by charging fees for transactions. But even though institutional investors have significantly more assets on the platform and trade more often, 95% of that transaction income comes from retail investors.
Coinbase needs to monetize institutional investors better, but for now let’s accept the business model for what it is. Based on the numbers we’ve seen, it needs to expand its retail investor user base to grow its core business, and it has a number of ways to do that.
First, Coinbase can expand the list of cryptocurrencies it supports. For those who don’t know, there is thousands cryptocurrencies, and each requires a specific support infrastructure. You can’t just throw them on the platform.
To the company’s credit, it added 22 new crypto assets in the second quarter alone, a quarterly record. And perhaps that is part of the reason why it has seen a strong growth in the number of users. It had 8.8 million monthly transaction users in the second quarter, down from just 1.5 million in the same quarter last year.
Second, Coinbase can go international. At present, the company is working to enter Germany and Japan. This is a challenge, as each country has its own regulations regarding cryptocurrencies. However, with such a small user base, Coinbase has an oversized chance to grow by expanding its network overseas.
Many investors rightly approach Coinbase shares with great caution. Cryptocurrency has always been volatile, motivating people to trade often. Remember: the business profits disproportionately with frequent transactions. Therefore, if trade declines with increased stability of the cryptocurrency, its business model could collapse.
However, consider two things. First of all, potential Coinbase investors are compensated for this risk with low-cost action. The company is very profitable and trades only 22 times dragging profits, according to data from YCharts, an almost unprecedented valuation for a fintech share.
Second, Coinbase puts its money back into the business. According to management, its capital allocation strategy has 70% of the capital invested to improve the core business, 20% used for strategic investments and 10% devoted to innovation with new products. Experienced investors will recognize this last element as the desirable trait called optional.
Here are two examples of the optionality of Coinbase. First, the company supports popular cryptocurrency Bitcoin. But it now has a feature called Bitcoin Borrow, allowing users to borrow money using Bitcoin as collateral. It also recently launched Coinbase Card from Visa so that users can spend their cryptocurrency on everyday purchases.
Coinbase Cloud is a more compelling example of this option. Cryptocurrencies live on blockchains, but they’re not the only thing that can be built on the underlying blockchain technology. Various decentralized applications can also be built on blockchains, and Coinbase wants its cloud product to become the de facto these are built. Management envisions Coinbase Cloud becoming like Amazon Web services but for cryptocurrency. It could be a huge opportunity if cryptocurrency becomes a bigger and more sustainable movement.
A wallet turbocharger?
In summary, Coinbase stock is a risky investment, as its primary source of income has questionable longevity. However, the company cannot be completely ruled out, as its current growth gives it the option offered by its significant financial resources. Its non-transaction-based income has grown more than 15 times over the past 12 months, so it’s clear that Coinbase is mitigating the risks to its core business by developing other sources of income.
The cryptocurrency space is still young, so it’s hard to predict what it will look like in five to 10 years. However, if you are thinking that cryptocurrency is still in its infancy, then Coinbase stock seems worth adding to a diverse portfolio.
However, I wouldn’t make a big bet on Coinbase shares today. The risk that cryptocurrency trading volumes decline is still relevant. But if this company implements its vision, then even a small portfolio allocation could increase your overall returns in the years to come.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.