The shares of buy now, pay later (BNPL) provider Zip Co Ltd (ASX: ASX:ZIP) are experiencing a decline on Monday. At the time of writing, the shares have fallen by 6.96% to AU$1.58 apiece. This decline comes despite the recent announcement that the company will soon rejoin the benchmark ASX 200 index.
Reason Behind the Share Drop
Investors are offloading Zip shares this morning despite the positive news of its imminent return to the ASX 200 index. After the market closed on Friday, S&P Dow Jones Indices declared that Altium Limited (ASX: ALU) will be removed from the ASX 200 index following its acquisition by Renesas Electronics Corporation. Consequently, Zip Co Ltd will take Altium's place in the prestigious index on Monday, 22 July.
Potential Upsides for Zip Shares
The inclusion of Zip in the ASX 200 index could bode well for its shares for several reasons. Firstly, ASX 200 index funds will need to purchase Zip shares to reflect the changes, potentially creating upward pressure on the share price. Secondly, many fund managers adhere to strict investment mandates, often requiring them to invest only in companies within the ASX 200 index. This mandate helps prevent investments in speculative stocks, which could lead to significant losses.
Fund managers who have been impressed by Zip’s performance in 2024 may now consider investing in the company’s shares, which they were previously unable to do due to these mandates.
Evaluating Zip’s Investment Potential
Zip’s journey towards profitable growth has been nothing short of remarkable. At one point, market sentiment was skeptical about the company’s ability to achieve profitability. However, Zip has defied these doubts in FY 2024, and it appears poised to continue its growth trajectory into FY 2025.
Market Performance and Valuation Concerns
Despite the company's impressive transformation, Zip shares have surged by approximately 300% over the past year. This significant rise raises the question: Is it too late to invest in Zip?
Current broker opinions suggest that Zip’s shares may have surpassed their fair value. For instance, Citi maintains a buy rating with a price target of AU$1.40, while UBS has a buy rating with a price target of AU$1.55. Based on the current share price, this indicates potential downsides of 15.5% and 6.5%, respectively.
Future Prospects and Caution
It is possible that these recommendations could be revised in August if Zip surpasses expectations with its full-year results. Until then, potential investors might want to approach Zip with caution, considering the current market valuation and the substantial gains already made by the stock.