Why Block Has More Growth Potential Than PayPal

While PayPal (PYPL 1.96%) may be an established cash-cow business, the much smaller Block (SQ 5.04%) has more opportunities for growth ahead of it. In this segment from "The Future of Fintech," recorded on Feb. 3, Motley Fool contributors Matt Frankel, Jason Hall, and Danny Vena discuss why Block has not only more growth momentum but more growth potential than fintech giant PayPal.

Matt Frankel: Why does Square trade at way higher valuations than PayPal? I don't know anyone that uses Cash App. Venmo is the default by a long shot. Now, I'm not sure I necessarily agree with the last part of that. I think Cash App has developed a very loyal following. It might not be the more popular of the two, but it has a lot more capabilities, specifically the ability to trade stocks that has really helped build it out in the past few years, the fact that it integrates with a lot of features in the Square seller ecosystem really helps. I think as they had features, it will be very sticky user base. It may not be the larger user base of the two. I think I'm pretty sure Venmo has that by a wide margin but I wouldn't cost Square's Cash App a niche product by any stretch of the term.

As far as why does it trade at higher valuations, it's because it still has a lot more growth. I mentioned that Square's revenue was up. Gross profit rather was up 46 percent year-over-year, whereas PayPal's forecasting in a 15-70 percent. Revenue growth this year, Square is not consistently profitable, but with growth like that, it doesn't need to be. The short answer is because it has not only more growth momentum but more growth potential. I mentioned it's a much smaller business than PayPal, it's really going after fintech from several different angles. I'd say that's why. Guys, any thoughts?

Jason Hall: Yeah, here's the growth rate over the past three years. I think that says it. The revenue numbers are starting to to take closer and closer together, but there are more channels, to your point, just that visual illustration I'm going to get to, but I think there are more channels that Block is pursuing to grow than where PayPal is looking to grow.

Matt Frankel: You can always count on Jason for on the spot Y-chart.

Jason Hall: I'm your man. [laughs]

Danny Vena: Jason is the Y-chart master. I would just quickly add. When you start looking at businesses that have greater opportunities like you both alluded to versus businesses that have a more narrow focus, you're going to see a difference in the growth rate and you're also going to see a difference in the valuation and that's pretty normal.

Matt Frankel: The Cash App is the most exciting growth driver of the business and just look at this. This is Cash App gross profit over the past five years. It's a six-year chart but if you've noticed, it didn't exist in six years ago. It essentially started from nothing. In 2021, I'm willing to bet it's going to be more than half of Square's gross profit. That's a phenomenal growth driver. If you just look at the green part of that chart, you'll see why the marketplace is a higher valuation multiple on Square than it does PayPal.

Jason Hall: I just want to hit one thing to really be clear about the answer is there's also more risk at that higher valuation, because you are paying a higher premium expecting that it will continue to grow at a higher rate.

Matt Frankel: Right.

Jason Hall: The corollary of that is if it doesn't grow at a higher rate, there is a larger chance of a permanent loss of capital if the company stumbles, the valuation readjusts down to those new expectations, so you have a higher floor with the very cash-cow business that is PayPal. It's about managing your risk in your portfolio as well as the upside.