The latest earnings season has barely begun, but mentions of artificial intelligence (AI) on conference calls are more than twice what they were last year, according to Bloomberg. Therefore, AI is the hot topic of 2023. And fintech company Block (SQ 0.29%) has officially entered the conversation.
To be clear, almost all technology companies have used some form of AI or machine learning for years now, Block included. That said, I was a little surprised to see Block jump on the generative AI train because it's hard to envision how such a thing could be used. But as it turns out, there is a use case. The question, however, is whether it's something that could benefit shareholders.
How Block can use AI
While AI is often used to find patterns in large datasets, generative AI takes the patterns and creates digital content automatically. In its letter to shareholders, Block's management mentioned two generative AI capabilities specifically for its Square ecosystem, its business segment for merchants.
First, Block's management launched a feature that suggests actions a merchant should take based on what the customer says in a message. This could include sending a bill or sending a coupon. Second, Block's generative AI allows merchants to create descriptions automatically for their merchandise.
Do merchants want features like these? Apparently so. According to Block's management, merchants have performed the AI's suggested action more than one million times since the feature launched in March. Moreover, merchants have used item descriptions from the generative AI without editing about 75% of the time.
Image source: Block.
Will AI help Block stock?
Block's Square ecosystem is extremely important to the business, accounting for 43% of its total gross profit in the first quarter of 2023. However, growth for the Square ecosystem is increasingly challenged. After posting year-over-year gross-profit growth of 54% and 30% in 2021 and 2022, respectively, Square's gross profit was only up 16% in Q1 compared to the prior-year period.
So will AI help reinvigorate growth into Block's Square ecosystem? It's tempting to think about it that way. But it doesn't appear to be how management is thinking about it. In talking about the trends changing the world, management wrote, "We want to be proactive in our approach, and not just react when it's too late."
To me, this sounds like Block's management is saying that generative AI could become table stakes for fintech companies in the future. Therefore, AI isn't so much a way to win the game but rather to stay in the game.
How should shareholders think about this?
I don't believe Block's new generative AI capabilities will lead to explosive growth. But I also don't believe Block needs explosive growth to generate strong shareholder returns. As of this writing, the stock is completely flat over the past five years, even though the business has grown at a magnificent rate.
SQ data by YCharts. TTM = trailing 12 months.
Growth has been stellar for Block. And even with challenged growth in the Square ecosystem, the Cash App ecosystem still provides plenty of upside for the business. If Block can be faulted for anything over the past five years, it's in the area of cash flow -- expenses have spiraled out of control in recent quarters, which explains why the stock is underperforming the market right now.
The good news for shareholders is that Block's management has acknowledged this shortcoming and prioritized correcting it from here. While management's framework can be a little hard to explain without diving into some accounting jargon, I believe the heart of the framework can be explained like this: Block is focused on growth while simultaneously accounting "for ongoing costs of the business."
I don't believe AI should be the central tenet if you're trying to build an investment thesis (an explanation for why the stock will go up) for Block. But AI can keep Block in the game as the industry evolves. And if Block can stay in the game, it has a chance to continue on its growth trajectory. Moreover, with a renewed focus on keeping costs under control, profit growth can bounce back.
With the stock trading at one of its cheapest valuations since going public in 2015, a lot of investors have written Block off. But I believe the balance between risk and reward is in investors' favor today, making it a stock worth considering for your portfolio.
