Fintech as a sector hasn't fared well in 2022. Cathie Wood's Ark Invest Fintech Innovation ETF, for example, is down 62% in 2022. Fintech isn't limited to unprofitable tech stocks in the financial industry; companies such as Visa and American Express have strong fintech elements, and their stocks are beating the market this year.
But the unprofitable tech stocks are pulling the sector down. Block (SQ 5.04%), once a high-flying growth stock with an astronomical valuation, is down 59% in 2022. Its valuation has dropped from more than 15 times trailing-12-month sales to only 2, which is quite cheap for a growth stock. But I wouldn't buy Block stock right now.
Block has huge opportunities
Block powers digital financial transactions for two separate businesses. The first is Square, what used to be its eponymous business, which is focused on merchant transactions. Square sells both hardware, such as Square terminals, as well as financial solutions such as digital credit card processing. It has expanded its services and created a full ecosystem to help merchants runs their businesses. Square sales increased 27% year over year in the third quarter, with a 29% increase in gross profit.
Block completed its acquisition of buy now, pay later company Afterpay last January. That has added revenue to the system but also piled on short-term expenses as Block integrates the platform into its own. This is a steadily growing business with a large market opportunity.
The second segment is Cash App, which was originally a peer-to-peer payments app and has become a full personal financial services app. The Cash App card has become a major growth generator for active customers, and management is investing in ways to make it easier for customers to fund their cards through its banking services. Cash App revenue increased 12% over last year in the third quarter, while gross profit rose 51%.
Is it falling behind its peers?
Block's growth is not exactly skyrocketing. For a simple comparison, PayPal's revenue increased 11% in the quarter and it posted $1.15 in earnings per share, a 26% year-over-year increase. Block's losses don't seem to be justified with that level of growth when competitors are demonstrating double-digit growth and also posting profits.
Block's profitability has been spotty the past few years. The losses over the past three quarters were mostly due to the Afterpay acquisition, but before that, Square had strong profitability.
SQ Net Income (Quarterly) data by YCharts
Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) in the third quarter were $327 million, or a 40% increase over last year. Management added in many adjustments to get to that number. Management said it would focus on reining in spending in 2023 to get to better operating leverage.
The Bitcoin bit
Block's revenue growth was weighed down by its investments in Bitcoin. Without Bitcoin trading, Block's revenue increased 36%, which is way ahead of PayPal.
Chief Executive Officer Jack Dorsey is a big proponent of the cryptocurrency, seeing it as a native token of the internet that provides a foundation for web-based commerce. Not only did Block invest more than $200 million in Bitcoin, but it also has two segments, Spiral and TBD, that actively work on its development.
This is the part that gives me the most pause about investing in Block. An investment in Block today is at least partially an investment in Bitcoin, since it has a huge impact on the company's total results. It might be a safer way to invest in Bitcoin, since Block runs other successful and valuable businesses. But Bitcoin is an important part of it nonetheless.
The business is strong, but the risk remains
There's a lot to like about Block, and most of its businesses are demonstrating the kind of growth that made Block a celebrated growth stock for so many years. Its stock gained more than 500% from 2018 through 2021 alone.
However, you have to be a believer in Bitcoin to want to buy Block stock right now. You also have to believe that it can continue to achieve high growth rates while slowing spending. For that part at least, I would want to see some concrete measure that it can achieve that before I invest. Therefore, I would hold off on buying Block at the moment, even at this cheap price.
