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Is now a good time to buy Zip (ASX:Z1P) shares?

Zip Co Ltd (ASX: Z1P) shares have been some of the most traded on the ASX recently.

Zip shares are trading at a significant discount to previous levels that we’ve seen this year, so some investors believe this could represent a good buying opportunity. Here’s my take.

Z1P share price chart

Source: Rask Media Z1P 1-year share price chart

Some of my thoughts about Zip shares

Zip and Afterpay Ltd (ASX: APT) have undoubtedly been two of the most popular shares on the ASX this year. Afterpay was clearly the market favourite and has since rewarded its investors with that staggering 10x return.

Zip shares also did well since March, but I really think it was the success of Afterpay that flooded buyers into the BNPL market in the hope that Zip would be the next Afterpay success story.

Comparing market capitalisations of companies can be a useful tool to get a rough idea of size and value. Although, something I’ve noticed is that people tend to compare Zip’s lower market capitalisation of $3.6 billion to Afterpay’s much larger capitalisation of $28 billion and assume that Zip has “more room to grow” to achieve a similar valuation of Afterpay.

This method of ”valuation” (if you could even call it that) is not a reliable way to measure value or predict future price movements because it assumes that Afterpay’s market capitalisation is fairly valued in the first place, therefore making it inappropriate to use in any sort of comparable valuation analysis.

To put Afterpay’s valuation into a little bit of perspective, it currently trades on a price to sales (P/S) ratio of 63. Most companies in the financials sector trade on a price to earnings (P/E) ratio of less than 10.

You can work out the implied earnings that Afterpay will need to earn to justify the current market capitalisation and what you’ll find is that the implied earnings are simply unrealistic, at least in the short to medium term.

Summary

For me, it’s too hard to get a sense of value when it comes to some of the bigger names in the BNPL space. Every week there seems to be a new company with “pay” on the end of its name. IOUpay Ltd (ASX: IOU), Zebit Inc (ASX: ZBT) and FuPay are just a few that have come into investors’ eyes within the last few weeks.

Increasing amounts of competition is bad news for the players with valuations that are already stretched, so BNPL is an area that I’m happy to sit out on the sidelines for the moment.

If you’re keen to learn more about the BNPL landscape on the ASX, grab a copy of our 7,500-word analyst report by following this link.

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At the time of publishing, the author of this article does not have a financial or commercial interest in any of the companies mentioned