Why Chime Financial Rallied in August

Shares of Chime Financial (NASDAQ: CHYM) rallied 44% in August, according to data from S&P Global Market Intelligence.

Chime delivered an excellent second-quarter earnings report, showing stronger-than-expected growth and a significant inflection in profitability. With the stock having sold off since going public a little over a year ago, it's no surprise to see a rally in response to the strong numbers one year later.

Chime's margins skyrocket in Q2

In the second quarter, Chime's revenue grew 27% to $670 million, with earnings per share swinging from a loss in the prior-year quarter to a positive $0.07. Both figures handily beat analyst expectations. Chime also raised its full-year revenue guidance to between $2.725 and $2.745 billion, up from the prior quarter's range of $2.66 billion to $2.69 billion, and adjusted EBITDA (earnings before interest, taxes, and depreciation, and amortization) between $465 and $475 million, up from the prior quarter's guidance between $416 million and $431 million.

While revenue growth came in ahead of expectations, the real story appeared to be the company's skyrocketing profit margins. Second quarter adjusted EBITDA margins of 15% marked a more than 12 percentage point improvement relative to the year-ago quarter.

That's a big inflection in Chime's profitability, and shows the company can grow at a very healthy pace with little to no incremental spending. In the company's presentation, management showed that Chime has generated 24% more revenue per member over the last four years, even as the cost to serve each member has decreased by 35% over that period.

In its prepared remarks, Chime management cited the effective use of artificial intelligence in its back-office and marketing functions as a driver of cost efficiency.

Chime also introduced Chime Prime in April, in which members who deposited at least $3,000 into their Chime accounts every month earned extra rewards. Management pointed to the new program as benefiting second-quarter activity. Chime also just introduced Chime Invest in July, allowing users to buy stocks and exchange-traded funds commission-free.

Both efforts seem geared toward giving the fintech's lower and middle-class consumers some of the perks and benefits usually reserved for higher-earning customers at larger banks.

Image source: Getty Images.

Chime is firing on all cylinders, but is it enough?

The second quarter was no doubt a strong one for Chime. Currently, the stock trades at a market cap of $12.8 billion, or roughly 4.7 times this year's revenue estimates, and roughly 27 times this year's EBITDA guidance.

That's not exactly "cheap"; however, if Chime can continue expanding its margins as it has over the past year, Chime could make for a solid growth stock at a reasonable price.

One word of caution is that Chime doesn't actually hold its own deposits, nor does it bear direct risk of loans it originates. Instead, it relies on partner banks. Therefore, Chime seeks to present itself as more of a "tech" company than a bank or financial institution.

That business model is meant to "derisk" Chime's business, separating the tech part of the company from the financial risks inherent in the financial industry. However, if and when times get tough, investors should recognize that Chime relies on external institutions to manage some of its risk. That could pose risks to Chime's growth that may not be directly reflected in its financial statements.

This is especially true as Chime targets a generally lower-income consumer than some other fintechs in the space. While that means Chime's total addressable market is extremely large -- Chime puts its total addressable market at $426 billion -- that target customer may come under pressure if the economy goes into a downturn.

All in all, however, Chime appears to be executing well and is a very interesting growth stock to track one year after its IPO.

Billy Duberstein and/or his clients have 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.