In late 2021, Square Chief Executive Officer Jack Dorsey announced radical changes to his company's direction, including changing its name to Block (SQ -1.97%). He also changed the company's identity from a payments company to one that creates tools and services for tailored audiences. Unfortunately, these changes had terrible timing and many investors were dubious about several of the company's strategies; at the same time, the economy took a turn for the worse. Nervous investors ran for cover, sending the stock down 61% year to date.
However, investors should strongly consider buying this fascinating ecosystem of businesses. Here's why.
1. Management is changing Cash App into a shopping destination
Block purchased buy now, pay later (BNPL) platform Afterpay in late January 2022. BNPL is an interest-free installment loan for shoppers. Until recently, investors were unaware of why management made this risky acquisition. However, on Block's third-quarter 2022 earnings call, Dorsey revealed some of the company's plans for Afterpay.
It wants to use the acquisition to link its Cash App and Square ecosystems to create a commerce destination. The Discover tab in Cash App is its first attempt to create a commerce destination. This new feature makes it easy for customers to search for BNPL offers from merchants who accept Cash App Pay. Moreover, customers can check out through Cash App using a QR code, either online or in person.
One huge reason Dorsey chose Afterpay to power Cash App payments is that the BNPL market is flourishing. Allied Market Research projects the BNPL market to grow at a compound annual rate of 45.7% from 2021 to 2030, reaching a total global market size of $3.98 trillion. Additionally, Afterpay is a great way to tap into younger consumers who prefer BNPL over other payment solutions. As an early player in this market, Block could generate juicy returns over the long term through this new form of payment.
2. A resilient investment in a challenging market
Block sells at a price-to-sales (P/S) ratio of 2.22, a far cry from its median P/S ratio of 6.7 in the past 10 years. Many investors would consider the company undervalued.
SQ PS Ratio data by YCharts
The stock has sunk to such a low valuation because the economy has reduced the profitability of many of Block's services. For instance, one of its largest businesses is Square, the payments system that services many small business clients, large numbers of which are highly vulnerable to inflation and rising interest rates. Unfortunately, inflation has risen to its highest level in the past 40 years. And the Federal Reserve has responded by raising the interest rate faster than it has in decades -- crushing many entrepreneurial businesses.
Square is far from immune when its small business clients suffer these headwinds. For example, Square's third-quarter 2021 gross profit rose 48% year over year when rebounding from the pandemic downturn. In contrast, in a sluggish market environment, gross profits in its third quarter of 2022 only grew 17% year over year (excluding the Afterpay acquisition).
Nevertheless, considering the headwinds, Square is a resilient business that still produces revenue at a solid clip. Additionally, Block has several other factors making it a worthwhile investment.
First, Square's seller business opportunity is still early in the game. The business has only captured 7.5% of a more than $85 billion U.S. market. In addition, management believes this addressable market can rise to more than $100 billion over time. As the economy improves and Square continues pursuing opportunities to move upmarket and internationally, its seller ecosystem should perform solidly over the long term.
Image source: Block.
The second factor favoring Block is diversification. When one or more of its businesses underperforms, it has others to pick up the slack. For instance, Cash App is now its fastest-growing operation, offsetting weaker Square and cryptocurrency growth in a down market.
Last, Block has enough resources to live to fight another day. Should the market significantly deteriorate, Block has $6.5 billion in cash and marketable securities to see the company through tough times to the next bull market.
Should you buy the stock?
If you follow the financial news, you might see experts speculating about when inflation will peak or when the Fed might pivot to lowering interest rates. This information could be helpful for those looking to engage in market timing. However, predicting interest rates is an inexact science, and it is often foolish to attempt to time the market.
Instead, suppose you are a long-term investor. In that case, the best way to approach investing is to put your money into a good business, like Block, that can survive inevitable downturns while outperforming over three to five years.
