Short Sellers Are Targeting SoFi. Should You Panic?

The market may be close to all-time highs, but that has not prevented carnage from happening across many sectors. One stock that has recently been hit is SoFi Technologies (NASDAQ: SOFI). Down close to 50%, the financial technology company keeps growing quickly but was recently targeted by a short seller alleging potentially misleading accounting that would wipe out the company's profitability.

Should you panic over this short report on SoFi? Or is the stock a buy now?

Short seller allegations

First, let's talk about the short report. Muddy Waters, which tries to profit from falling share prices, is a famous short-selling firm that makes bold claims against high-flying companies popular on Wall Street. Sometimes its allegations are right. Sometimes, they are wrong.

In this case, Muddy Waters alleges that SoFi is purposefully misstating its financials for its personal lending business, making its loans appear much more profitable than they actually are. The firm claims that SoFi is retaining risk on loans it sells to third parties for fees, reporting a lower loss ratio for delinquent loans than in reality, and funding third parties to buy its packaged debt, a practice known as circular accounting.

Today, it is unclear whether these allegations are true, but Muddy Waters is making some bold claims about this fast-growing digital bank. SoFi's management immediately came out and said the report was false and was trying to mislead shareholders. It remains a risk for SoFi until it can prove to the market that each of these allegations is incorrect.

Image source: Getty Images.

A fast-growing business

If you look at SoFi's actual business, it appears to be just fine based on its financial statements. Deposits at its digital bank are growing rapidly, with customers increasing 41% year over year last quarter. Adjusted revenue rose 41% year over year, and the company is now net income positive. The company has achieved significant scale in digital banking and now offers clients a range of financial tools, including high-yield savings accounts, personal loans, and insurance products. It wants to be a one-stop shop for a customer's personal finances.

With the stock down from its highs, you might think SoFi is trading at a cheap price-to-earnings (P/E) ratio. It is not. The current P/E is 43, which is high even for a fast-growing banking operation. And this is assuming none of what Muddy Waters is alleging is true. Don't panic about the short report. However, with both these factors in mind, it is probably best to avoid buying the dip on SoFi stock right now.

Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.