Although shares of Block (SQ 2.32%) are currently 71% below their peak price (as of March 22), they have been trending higher recently. Thanks to a strong fourth-quarter financial update, shares have soared 25% in the last month. Investors might be eyeing the company right now.
Here's one reason this fintech stock is a screaming buy, and one reason to avoid it like the plague.
Reason to buy: Two thriving ecosystems
Investors probably know Block by its former name, Square. But these days, Square is the name of the company's merchant-focused segment. It offers a wide range of hardware, software, and financial services that help business owners better run their operations, including point-of-sale devices, marketing tools, loyalty programs, team management, and working capital loans.
Then there's Cash App, an extremely popular personal finance tool that's currently the top-ranked finance app on the Apple App Store. Not only can users send money to other users on Cash App, but they can buy stocks, set up direct deposit, do their taxes, and sign up for a debit card. For about 56 million monthly active users, Cash App is becoming a banking substitute.
Both of these segments continue to experience rapid growth. Square and Cash App posted gross profit gains of 18% and 25%, respectively, in 2023. By constantly introducing new features, it's not too difficult for Block to continue to add more users, boost payment volume and engagement, and monetize this activity.
Looking ahead, management believes there is a ton of growth potential. It's estimated that combined, Square and Cash App have total addressable markets of $190 billion (based on gross profit). Looking at 2023 numbers, the business has only penetrated 1% of this opportunity.
Consequently, Block benefits from some competitive advantages. It's easy to believe there are switching costs present. Merchants that have onboarded with Square's services and rely on it as a mission-critical provider are probably locked in given the headaches it would cause to change to competing products.
Like other banks, Cash App could experience the same thing as Square. Once you start using a financial services provider, it's a pain to switch to another bank.
Reason to avoid: Lack of consistent profits
As is the case with many other growth-oriented businesses, Block has foregone bottom-line performance in the name of rapid expansion. The net loss totaled $541 million in 2022. The business has yet to be fully profitable on a sustainable basis, even though it generated a positive net income of $9.8 million in 2023, thanks to a sizable Q4 profit. Some investors might view this as a dealbreaker.
This isn't surprising. When a management team sees a huge opportunity ahead, they plow resources into sales, marketing, and product development efforts. The hope is that profits can be achieved in the future at a much greater level of scale.
But founder and CEO Jack Dorsey is tightening the grip on the company. He has capped the employee headcount at 12,000. And Block is focused on driving greater efficiencies by reducing overhead costs.
The outlook calls for an adjusted operating income of over $1.1 billion in 2024. Wall Street is also optimistic, forecasting generally accepted accounting principles (GAAP) operating income of $842 million this year. This is encouraging, but unless the company can start posting consistency with this figure, then there will always be a financial risk, particularly with fears about how a recessionary period will impact the business.
Understanding the fact that Block has a long way to go when it comes to sustainable positive earnings, I still think the stock is worthy of a place in a long-term portfolio.
