The stock market can be fickle, particularly in the short term. But over time, companies that continue to deliver strong financial results are rewarded, along with their shareholders. That's why it pays to invest in equities that are arguably trading below their intrinsic value. Let's consider two stocks currently priced at only a fraction of what Wall Street analysts think they are worth: Block (SQ -1.97%) and Chegg (CHGG 1.88%).
1. Block: Implied upside of 95.5%
Block, the company is formerly known as Square, changed its name in December to reflect the fact that it has evolved beyond the business that first made it famous. Block initially burst onto the scene and rose to prominence thanks to the suite of products it offered small and medium-sized sellers and merchants: the ability to turn almost any mobile device into a point-of-sale system. But now, it provides much more than that, and in particular, it has branched out into personal finance and banking services through Cash App. Block's traditional seller business and its Cash App are performing very well.
In the third quarter, the tech giant recorded $3.8 billion in total revenue, 27% higher than the year-ago period. Block reported a total gross profit of $1.1 billion during the quarter, representing a 43% year-over-year increase. Its seller ecosystem contributed $606 million in gross profit, jumping by 48% compared to the third quarter of 2020. In addition, its Cash App's gross profit came in at $512 million, 33% higher than the prior-year quarter.
Image source: Getty Images.
Block broke even during the quarter, which some investors may be worried about. Indeed, the company hasn't been consistently profitable, but it is fair to overlook the occasional red ink on the bottom line given its long-term prospects. That's because as finance and banking become more digital, Block has already positioned itself to be a leader in this space while it competes almost directly with traditional brick-and-mortar banks.
Block now offers a slate of services including direct deposits, debit cards, and the ability to purchase stocks and cryptocurrencies. The company recently started offering these services to teens, with parental guidance, of course. As Block argues: "Historically, teens have been underserved by not having broad access to financial services, and both parents and teenagers have expressed desire for these types of products."
Block's Cash App alone boasts a significant growth potential within the fast-growing fintech industry. The company's combined opportunities throughout the range of the services it offers are massive. That's why despite its underperforming the market last year, Block's average price target of $285.88 -- according to Yahoo! Finance --is well within the company's reach.
2. Chegg: Implied upside of 75.8%
In early November, shares of the learning platform Chegg dropped by nearly 50% in one day. Investors weren't pleased with the company's third-quarter financial results and the guidance it issued for the fourth quarter. Chegg is yet another one of those companies that benefited from a switch to online activities at the pandemic's peak. But last year, the company experienced a significant slowdown due to a combination of factors -- leading to fewer student enrollments for its Chegg services.
In the third quarter, Chegg recorded revenue of $171.9 million, representing a 12% year-over-year increase. That's well below the kind of year-over-year quarterly top-line growth the company has historically produced. While the headwinds the company is facing are real, it believes they are temporary, and that's why management approved a $1 billion share repurchase program in November.
This move shows the confidence Chegg has in its own business, and in my view, this confidence is justified. Chegg had 4.4 million subscribers for its Chegg services in the third quarter, 17% higher than the year-ago period.
Image source: Getty Images.
The company thrives on its ability to deliver expert solutions to questions and textbook problems to these subscribers. The more students join the platform, the more it will attract subject matter experts to answer complex questions, and the more questions answered, the more students looking for these kinds of services will join the platform.
That's what's known as the network effect -- when the value of a product increases as more people use it. According to management, Chegg had 70 million unique questions in its database as of the third quarter. That's the company's weapon to attract more students onto its platform in the coming years, and there remains significant growth potential. The company estimates that 102 million students worldwide could benefit from its services.
That gives plenty of room for Chegg to increase its user base and its revenue and profits. That will help justify the confidence both management and Wall Street -- the company has an average price target of $51.50 -- have in the business.
A word on valuation
A correction was arguably long overdue for Chegg and Block, as both were trading at crazy valuations. Looking at each company's forward price-to-sales (P/S) ratio, they both seem a lot more attractive now. Chegg's forward P/S ratio currently stands at 5.1 -- which is about as low as it's been for well over a year.
Meanwhile, Block's forward P/S is a 3.7, which is also near a 52-week low. These figures are more than fair for companies with the kind of potential Chegg and Block have. Wall Street isn't always right, but its expectations are justified when it comes to these two tech stocks.
