3 Reasons to Buy Block, and 1 Reason to Sell

Block (SQ -2.21%), the fintech company formerly known as Square, lost nearly half its market value over the past three months as rising interest rates sparked an exodus from higher-growth tech stocks. Declining Bitcoin (BTC -0.98%) prices exacerbated the sell-off, since Block generates revenue from Bitcoin trades and holds some Bitcoin on its balance sheet.

Block's big pullback in this environment isn't surprising, but the stock has still nearly doubled over the past two years. Could it still have more room to run after overcoming these near-term macro headwinds?

Let's discuss three reasons Block is worth buying -- and one reason to sell it -- to decide.

Image source: Block.

1. The Cash App is growing users, services, and revenue

Block launched its Cash App as a peer-to-peer (P2P) payments app in 2013. But over the past few years, it evolved into a "super app" for Bitcoin trades, free stock trades, and digital banking services. Block's pending acquisitions of Intuit's Credit Karma Tax and Afterpay (AFTP.F) will also integrate tax filing services and "buy now, pay later" (BNPL) services, respectively, into the Cash App's ecosystem.

The Cash App's number of annual active transacting customers hit 70 million last August. That's up from 36 million at the end of 2020, and makes it nearly as large as PayPal's (PYPL -1.85%) P2P payments app Venmo -- which surpassed 80 million active customers last year.

The Cash App grew at a much faster clip than Block's seller business -- which mainly generates revenue from transaction processing fees, subscription services, and hardware sales -- in recent years. The Cash App's growth also accelerated significantly throughout the pandemic as its Bitcoin trades soared, and it continues to thrive in a post-lockdown market:

Source: Block.

The Cash App will inevitably face tougher year-over-year comps in 2022 and beyond as its user growth decelerates and Bitcoin's price stabilizes, but it could still disrupt traditional banks and brokerages over the long term. That disruptive potential should draw more growth-oriented investors back to Block when the market's appetite for risk finally returns.

2. The seller segment is recovering from a post-lockdown hit

Block's seller segment, which usually generates higher-margin revenue than the Cash App, suffered a major deceleration during the pandemic as brick-and-mortar businesses closed down. However, that business recovered quickly throughout 2021 as the pandemic-related headwinds waned.

Source: Block.

That acceleration should stabilize Block's gross margins by reducing its overall dependence on the Cash App, which experienced a margin contraction as it generated more revenue from low-margin Bitcoin trades.

Source: Block. *Excluding its sale of Caviar.

The seller segment's expanding margins indicate Block's Square-branded products and services still have plenty of pricing power against PayPal, Adyen (ADYE.Y -17.29%), and other competitors in the digital payments market. That stability should also give Block more freedom to expand the Cash App with lower-margin and loss-leading strategies.

3. The stock is historically cheap 

Block might initially look expensive at 85 times forward earnings. But just like many other higher-growth stocks with inconsistent profit margins, its price-to-sales ratio is arguably a better way to gauge its value. By that measure, it looks historically cheap at just three times next year's sales.

PayPal, which is more profitable and generates more consistent revenue growth, trades at seven times next year's sales. Adyen, which is more comparable to PayPal than Block, trades at 40 times next year's sales.

The one reason to sell Block: Its Bitcoin mining ambitions

Block's addition of Bitcoin trades to the Cash App, as well as adding Bitcoin holdings to its own balance sheet, makes it a good way for investors to gain exposure to Bitcoin without directly buying the cryptocurrency.

But over the past year, CEO Jack Dorsey has repeatedly suggested that Block will build its own open source mining system to decentralize the mining market. It also said it could develop its own ASIC chip for those systems. That sounds like a very costly effort since big stand-alone Bitcoin miners like Marathon Digital are still deeply unprofitable.

If Block gets too distracted with building Bitcoin miners and developing its own chips, its Cash and Seller businesses could suffer.

I'm still bullish on Block

I've owned Block since 2018, and I'm still bullish on its long-term prospects. It's a wilder and more unpredictable fintech play than PayPal or Adyen, but its forward-thinking strategies could also enable it to disrupt traditional banks at a faster rate than either competitor.

Dorsey's embrace of Bitcoin mining is distracting, but I believe the man who simultaneously led Block and Twitter for six years can juggle those efforts while expanding its Cash and Seller businesses.

Therefore, investors who can stomach the near-term volatility should still consider accumulating shares of Block after its recent decline.