In the past six months, share prices of Block (SQ -0.19%), the company formerly known as Square, have dropped sharply along with many other growth stocks. Investors have been exiting this sector of the market, especially the stocks that aren't consistently profitable. There are increased concerns that perceived marketwide issues, including potential interest rate hikes in the U.S., could weigh on these companies.
Despite the bearish attitude toward the stock, Wall Street remains bullish on Block's future as a business. When averaging the price targets of various analysts following the stock, they think the stock price should be $242.53, according to Yahoo! Finance. That represents an upside of about 117% from the stock's current price.
Are the analysts right to place such lofty expectations on Block? I think so, and here's why.
SQ data by YCharts.
Block's original business can still drive growth
Novel and practical solutions to age-old problems are always welcome. Block was a pioneer in developing such solutions for businesses. Every company needs a way to process transactions. However, traditional point-of-sale (POS) systems are clunky and expensive. Block offered companies the ability to turn almost any mobile device into a POS system thanks to the slick hardware it provides and the accompanying software.
The company successfully built an ecosystem of sellers thanks to this, and it provided other services to these sellers, including payroll and data analytics tools. While Block's seller services are now somewhat widespread within the company's target market, there are likely scores of businesses out there that still don't use the company's products.
Block management once estimated that its seller business boasted a more than $100 billion market opportunity, with very low penetration. Block has the potential to make significant headway into this market in the coming years. Even capturing only a portion of it will help the tech company substantially grow its seller revenue.
Image source: Getty Images.
Block's Cash App is disrupting traditional banking
In addition to its seller ecosystem, Block's peer-to-peer (P2P) payment app, Cash App, has massive opportunities. The company is looking to provide traditional banking and other financial services to individuals via this app. It now offers a debit card, the ability to buy and sell stocks and cryptocurrencies, direct deposits, and tax preparation services.
Cash App recently extended some of these services to young adults between the ages of 13 and 17 (with parental guidance) for a straightforward reason: Block argues that teens have often been overlooked by the financial services industry. Block's mission with its Cash App is to precisely target those historically underbanked communities, and the company will continue to increase the range of services it offers.
In January, Block completed the acquisition of buy now, pay later (BNPL) company Afterpay in an all-stock transaction valued at $29 billion. The BNPL trend, which has been gaining steam, allows consumers to purchase items and pay for them on an installment basis, often with no interest. Block's acquisition of Afterpay will serve both its seller and Cash App ecosystems. As the company said in a press release, "Together, Square and Afterpay intend to enable sellers of all sizes to offer 'buy now, pay later' (BNPL) at checkout, give Afterpay consumers the ability to manage their installment payments directly in Cash App, and give Cash App customers the ability to discover sellers and BNPL offers directly within the app."
Block's most recent ventures, including targeting teens with its banking services and adding BNPL options to its business, will help attract new users onto Cash App, thereby helping the company grow its ecosystem. And that's great news for its long-term master plan.
Be aware of these risks
While Block's Cash App and seller ecosystems are booming and still have considerable room to grow, the company changed its name in part to reflect its increased focus on cryptocurrencies and the potential of the blockchain. CEO Jack Dorsey is very much a crypto enthusiast, to say the least, even going as far as asserting that Bitcoin will eventually replace the U.S. dollar. Block has invested heavily in Bitcoin, and it generates a significant amount of revenue from Bitcoin trading on its Cash App. The company recorded $1.81 billion in Bitcoin revenue in the third quarter, representing an 11% year-over-year increase.
But Bitcoin gross profit in Q3 only came in at $42 million. The company's total Q3 revenue was $3.84 billion, growing by 27% year over year, while its gross profit of $1.13 billion soared by 42% compared to the year-ago period. The company broke even during the quarter.
The market might increasingly perceive Block as a crypto play, and that could bring some added volatility as the crypto market is not the most stable in the world. Furthermore, Block still isn't consistently profitable, and in today's environment, that could disrupt the company's near-term progress.
Investor takeaway
Even with all these caveats, I see Block as an excellent long-term stock to buy, thanks to the potential that both its seller and Cash App ecosystems bring and the name recognition it has already garnered in its industry. I do not think the company's share prices will more than double in value in the next 12 to 18 months to attain the street's lofty price targets, but even if they don't, patient investors will be rewarded with solid growth down the road.
