Runaway inflation and rising interest rates have investors worried about a recession, and that has weighed on the stock market, erasing trillions of dollars in wealth. In fact, all three major U.S. indexes -- the broad-based S&P 500, the tech-heavy Nasdaq Composite, and the blue-chip-packed Dow Jones Industrial Average -- have slipped into a bear market this year.
Meanwhile, Block (SQ -1.65%) has seen its share price drop 78%, as traders have mulled concerns about its growth prospects in a weak economy. But there is a silver lining to that shortsighted logic for long-term investors. High inflation is temporary and Block is brimming with potential, and the stock is trading in the bargain bin.
Investors should jump on that buying opportunity. Here's why.
Block is disrupting two big markets
Block makes money through two product ecosystems. First, Square brings together all of the hardware, software, and banking services sellers need to manage omnichannel businesses. Its tools integrate seamlessly, unlike the bundled products offered by most merchant services providers. This enables the company to reduce cost and complexity for its customers.
Second, Cash App allows users to send, spend, borrow, and invest money from a single mobile platform. That convenience made it the most downloaded digital wallet in the U.S. during the first half of 2022. In fact, Cash App had more downloads in the U.S. than PayPal and Venmo combined.
Despite a challenging economic backdrop, Block reported decent financial results over the past year. Gross profit climbed 36% to $5.5 billion, and the company generated positive free cash flow (FCF) of $167 million. But Block values its total addressable market (TAM) at $190 billion in gross profit -- representing a $120 billion opportunity for Square and a $70 billion opportunity for Cash App -- meaning it has captured less than 3% of a large and growing TAM.
Cash App is becoming a shopping destination
Block has outlined a multi-step growth strategy that integrates its buy now pay later platform (Afterpay) into the Square and Cash App ecosystems. First, Square sellers will be able accept Afterpay online and in person, which should increase conversion rates and cart size. That step is already underway in the U.S. and Australia.
Second, Block will integrate the Afterpay Shop Directory -- a marketplace featuring products from 140,000 businesses -- into the Cash App, turning the digital wallet into a shopping destination. Eventually, consumers will be able to buy products from Afterpay and Cash App Pay sellers without leaving the mobile app. Theoretically, that will boost sales for businesses that accept those payment options, and it will enable Block to monetize the Cash App with digital advertising, much like Amazon monetizes its marketplace with sponsored products.
Third, Block plans to expand Cash App Pay -- a service that allows Cash App users to checkout with QR codes online and in person -- beyond the Square ecosystem. In fact, European fintech Adyen was recently selected as the first non-Square company to offer Cash App Pay to its merchants. For context, Adyen handles payment processing for businesses like Etsy, Uber, and Microsoft.
Collectively, those initiatives could create a powerful flywheel. Shopping capabilities should bring consumers to the digital wallet, which should inspire more businesses to accept Afterpay and Cash App Pay, further incentivizing consumers to adopt the digital wallet. For that reason, Deutsche Bank analyst Bryan Keane recently called Cash App Pay a "potential sleeping giant."
Image source: Getty Images.
Square is growing upmarket and expanding globally
Block is growing upmarket with Square. Its developer tools allow larger businesses to integrate Square software and services across mobile, web, and brick-and-mortar stores, and the cohesive nature of those products is driving adoption. In the third quarter, mid-market sellers (i.e., those with over $500,000 in annual sales) accounted for 40% of gross payment volume, up from 37% one year ago and 31% two years ago. To maintain that momentum, Block will continue building features into its premium point-of-sale (POS) software -- Square for Retail, Square for Restaurants, and Square Appointments. As the names imply, those products are tailored to specific verticals, and they provide sellers with more functionality than the basic POS software.
Meanwhile, Block is also expanding globally. Square launched in France and Ireland last year, and Spain this year, bringing the total to nine markets. As a result, international sellers accounted for 15% of gross profit in the third quarter, up from 9% one year ago and 8% two years ago.
The stock is trading at a bargain price
In a nutshell, Block simplifies financial services for sellers and consumers, and the company is executing on a strong growth strategy across both product ecosystems. Better yet, the stock currently trades at 2 times sales -- just above its all-time low of 1.6 times sales. That creates a very attractive buying opportunity for patient investors.
