In addition to growth tech stocks, one of the hardest-hit sectors in the recent market rout has been fintech businesses. And probably the most popular among them, Block (SQ -1.97%), has been particularly beaten down, as shares of this digital payments innovator have fallen more than 60% this year.
Now is a great time to consider what, if any, portfolio changes need to be made. Let's examine the investment merits of Block, which I believe make the stock a compelling buy right now.
Powerful two-sided ecosystem
At a high level, Block operates two primary segments. The first one is the seller ecosystem, known as Square, which offers small- and medium-sized businesses a range of different software, hardware, and financial services products to do things like accept payments, set up customer loyalty programs, and manage inventory. This segment produced a gross profit of $661 million in the first quarter of 2022, up 41% year over year.
Then there's Cash App, the popular personal finance app that now has 44 million monthly active users. While many people know Cash App as a tool to send money to friends, the platform also has additional services like direct deposit, a linked debit card, and buying and selling stocks and Bitcoin (BTC -1.79%). Cash App generated a gross profit of $624 million in the first quarter, up 26% compared to the same period last year.
While both Square and Cash App are fantastic fintech businesses on their own, what makes Block truly special is how both segments work together to strengthen the entire company. A feature known as Cash App Pay lets Cash App users pay with their balances directly at Square merchants. And with Block's acquisition of buy now, pay later specialist Afterpay, both Square merchants and Cash App users can use this innovative payment option.
As Block continues introducing new features that further integrate its Square and Cash App ecosystems, the company's network effects soar. With more consumers on Cash App, a greater number of small businesses will want to sign up to be Square merchants because they immediately have tens of millions of potential customers. And the more retailers that accept payments from Cash App, the more appealing having a Cash App account becomes. This situation gives Block a powerful competitive advantage.
Huge growth opportunity
Block has had tremendous growth in recent years, but the future still looks incredibly bright. As I've discussed above, both Square and Cash App already provide numerous services. But as the business continues to introduce new features, its customer base will become even stickier as revenue increases.
Additionally, the company can penetrate international markets. Currently, Block is in the U.S., Canada, Japan, Australia, the U.K., Ireland, France, and Spain. Yet in Q1 2022, the U.S. accounted for 94% of total sales. Therefore, there is still a huge opportunity to expand in foreign markets.
Block also owns and operates other lesser-known ventures. Tidal is a music streaming platform akin to Apple Music or Spotify, but that focuses on driving deeper connections between musicians and fans. Similar to Square and Cash App, Tidal aims to bring economic empowerment to those who have traditionally been ignored by larger incumbents.
Then there's Block's focus on advancing the use of Bitcoin, of which Chief Executive Officer Jack Dorsey is a huge proponent. With TBD, the goal is to develop a decentralized exchange to buy and sell Bitcoin without the need for a centralized service provider. And with Spiral, Dorsey wants developers to find ways to integrate the Lightning Network with crypto wallets and applications.
Block's business is ingrained in the world of digital payments and Bitcoin, so there are plenty of expansion opportunities ahead as the world moves toward cashless transactions and crypto becomes more mainstream.
Current valuation
A company's qualitative characteristics could be outstanding, but if the price isn't right, then investors should proceed with caution. But with Block's recent price crash, shares currently sell for a price-to-sales ratio of just under two, which is close to the cheapest valuation ever for the stock.
The right question to ask is why Block's stock price is so far removed from the company's underlying performance. Because of the Federal Reserve's intention to aggressively raise interest rates this year in an effort to curb inflation that's at a 40-year high, the threat of a looming recession is real. And investors have sold off expensive, high-growth stocks in favor of more conservative investments. Unfortunately, Block's shares have been among them.
But for long-term investors, this is a rare opportunity. Block is a fantastic business selling at a below-average valuation, making the stock a no-brainer buy.
