2022 has not been kind to growth stocks, and while the past few weeks have been a reprieve, there are still plenty of stocks down substantially from their all-time highs. Block (SQ -0.12%) and PayPal Holdings (PYPL 0.57%) are down more than 53% and 62%, respectively, from their 52-week highs, which were both set in mid-2021.
Some investors might see these two companies as a lost cause, but long-term investors should be excited about these lower prices. Both Block and PayPal dominate the fintech industry, and while their stock prices might be down today, their futures look bright. I have high hopes for Block and PayPal over the next five years because of each company's strong balance of expansion opportunities and leadership.
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1. Block
Block has taken the fintech market by storm, especially in the seller space. Its ecosystem has allowed businesses of all sizes to operate more efficiently, and Block has seen major adoption because of it. The Square ecosystem generated $2.3 billion in gross profit last year, driven by customers adopting more products. Of Square's 2021 gross profit, 38% came from customers using four or more products, and this has risen steadily since 2016. Considering these customers generated 10 times more gross profit than single-product users in 2021, growing this cohort will be a primary focus.
This strong adoption in the seller space was overshadowed by 69% year-over-year gross profit growth in its Cash App business last year. With so much prosperity, you would think that shares are trading near an all-time high. In reality, however, Block is trading at four times sales -- a valuation seen just once in the past five years. This major disparity between business performance and valuation could mean that long-term investors have an optimal buying opportunity today.
This company is not perfect, however. I am mainly concerned about its fixation on Bitcoin. Interest in crypto could be a smart business decision, but Block is solely focused on one coin, which could be costly. The cryptocurrency space is in such a young state, so diversifying across multiple currencies is likely the smartest play right now. However, CEO Jack Dorsey disagrees and has decided to bet the house on Bitcoin alone.
The investments Block has made will muddy its net income figures due to any loss or gain from the investment. In 2021, for example, Block reported a net income of $166 million -- including a Bitcoin impairment loss of $71 million. Net income fell 22% year over year because of it. Excluding that loss, net income would have jumped 11%. It's worthy to point out that this could work in the opposite direction as well. Either way, these investments will make the true business profitability unclear going forward.
This concern is overshadowed by the company's success across the board. With its rock-bottom valuation, I could see Block being a great investment over the long term from here.
2. PayPal Holdings
While Block has a big focus on the seller market, PayPal's core business is in consumer payments -- much to its success. The company had over 426 million active accounts on its platform that made 5.3 billion transactions in the fourth quarter.
Where the company shines is in its cash flow generation. In Q4 2021, PayPal's free cash flow soared 38% year over year. This helped its cash flow margins jump from 18% in Q4 2020 to 23% in Q4 2021. This cash generation will help PayPal shift to the new growth strategy it recently announced.
In its fourth-quarter conference call, management noted a shift of focus from acquiring new users to monetizing them more. This spooked investors, considering the growth model for PayPal has historically been to grow its user count at all costs. However, this strategic transition could be a good thing. Low-value active users generate little revenue for the company. More loyal users, however, are much more valuable and profitable. Moving attention to this cohort could result in strong returns on marketing expenses for the company, which would make its cash flows and profitability even more impressive.
Monitoring the success of this shift is critical over the coming year, but investors seem to have already left the company for dead. Shares trade at 5.6 times sales and 26 times free cash flow -- both of which are near five-year lows.
Investor takeaway
It would be difficult to imagine a life without small businesses using Square and consumers without Venmo or Cash App, and their resilient financials are applause-worthy. This is why I think the selling of these stocks is creating discounts for long-term investors. Bargains like these don't come around often, so it might be smart to take advantage of them now.
