What happened
Shares of Block (SQ -1.57%), formerly known as Square, rose as much as 19.2% this week, according to data from S&P Global Market Intelligence. However, after releasing its second-quarter earnings report after the close on Thursday, Aug. 4, the stock has fallen in after-hours trading, down 7.42% as of this writing.
So what
Even though the stock is down, Block's report looks solid at first glance. Gross profit was $1.47 billion in the quarter, up 29% year over year, with adjusted earnings per share (EPS) of $0.18. Both numbers slightly beat analyst expectations.
So what was wrong with the report? Well, it could have been the slowdown in growth excluding Block's buy now, pay later (BNPL) business, which was only 16% at the gross profit level in the quarter. Block heavily diluted shareholders by buying BNPL provider Afterpay last summer in an all-stock deal, which is contributing to heavy inorganic gross profit growth right now. For a company that was growing gross profit at 40% year over year or higher during the heart of the pandemic, this big slowdown (excluding inorganic BNPL growth) is likely why investors are selling off shares of Block in after-hours trading on Thursday.
Block's stock was up this week before earnings because of a broad movement in growth stocks. The Nasdaq 100 Index is up 4.66% in the last five trading days, and with over 6% short interest, it is possible Block's stock benefited from short-sellers buying back their shares this week, further driving up the share price. However, this short-term trend looks to be over, with how investors are reacting to Block's earnings.
Now what
If you're an investor in Block, these short-term price fluctuations shouldn't concern you. What you should be focused on is the health of the business and its potential to grow this decade. Block's top-line growth has slowed down significantly since the heart of the pandemic. While still growing at a double-digit rate, you need to be confident the company can continue growing its annual gross profit and eventually achieve operating leverage if you're going to own shares today.
At a market cap of $52.5 billion, Block trades at a fairly expensive trailing price-to-gross profit (P/GP) ratio of 11 right now. This is higher than the market average and indicates that Block's stock is expensive. If gross profit growth continues to slow down, shareholder returns will likely be below average for the next few years due to this expensive valuation.
