Block (XYZ 2.23%) is one of the worst-performing stocks of 2022. Down 62% this year, the financial technology (fintech) company has disappointed investors after putting up impressive returns in the 2020-2021 bull market. Declining valuations across the technology sector, profitability struggles, and a lack of confidence in the management team all likely contributed to Block's plight. However, despite all this pessimism, the company continues to put up strong top-line growth each quarter.
At first glance, a growing top line and a declining stock price might be music to the ears of long-term investors. But there are many looming concerns about Block right now that make me think investors should avoid buying shares in 2023.
Top-line growth has been strong
Block -- formerly known as Square -- has put up incredible growth over the past decade with both its business and consumer product lines. For businesses, it was the innovator in offering easy credit card payments for small businesses with its Square card reader, which has driven tons of payment volume flow through its platform. On top of this, it now offers a robust suite of software services to help small businesses succeed, including online payments, loans, and payroll services.
Square's gross profit (the key top-line number to use for Block) hit $783 million last quarter, up 29% year over year. Over the past three years, the segment has increased gross profit at a compound annual growth rate (CAGR) of 29% as well.
Block's consumer business is doing even better. The company has one of the top finance mobile applications in Cash App, which now has 49 million users making transactions through its app each month. With its peer-to-peer payments and neobank offerings, Cash App has increased its top line at a rapid rate over the past few years. Last quarter, Cash App's gross profit hit $774 million, up 51% year over year, and has put up a three-year CAGR of 81%. Growing 81% over three years is a rare feat and shows how fast consumers have started to adopt its consumer finance products.
As a note, investors should use gross profit when considering at Block's top-line growth, not revenue. The company is forced to realize all Bitcoin transactions through its platform as revenue even if they mostly have 0% gross margins, which artificially inflates or deflates its revenue growth each quarter. This is critical.
Concerns: Embracing crypto and unprofitable, bad acquisitions
If you just looked at gross profit growth at Block, you'd think the stock was an easy buy. But rarely is investing that easy. I have multiple concerns with Block at the moment, the first being its large investments in the cryptocurrency markets. In February 2021, right around the top of the latest Bitcoin bubble, Block decided to buy $170 million in Bitcoin for its balance sheet. That investment is likely down more than 50% at the moment.
On top of this, Block has started up multiple crypto business segments including Spiral (a funder of open-source Bitcoin projects) and something called TBD. It's not terrible to let people buy and sell Bitcoin through Cash App, which Block does. But taking hundreds of millions of dollars and investing in an entirely unproven sector is risky, to say the least.
These new investments have greatly contributed to Block's swing from profitability to losses over the past year. Over the past 12 months, the company has posted a net loss of $500 million and is showing no signs of a reversal. It doesn't matter how fast you increase revenue or gross profit, if you don't eventually generate bottom-line earnings you aren't creating value for shareholders.
SQ Net Income (TTM) data by YCharts
But that isn't the only thing wrong with Block. It has made numerous poor acquisitions over the years, including Caviar, dying music streaming company Tidal, and recently a $29 billion acquisition of buy now, pay later (BNPL) company Afterpay. Time will tell whether the Afterpay acquisition will work out, but the timing of the deal could not have been worse. BNPL went through a huge hype cycle in 2021, and Block decided to buy Afterpay right before the market rolled over.
For example, BNPL competitor Affirm Holdings is down 90% over the past year. Afterpay likely would have gone through the same perturbations had it remained an independent public company. Management has clearly shown a poor sense of capital allocation in recent years, which should concern any investor thinking of buying the stock today.
Block is an innovative and fast-growing fintech company. But with risky cryptocurrency investments, a lack of profitability, and a history of poor acquisitions, there are better opportunities for your portfolio in 2023.
