Of all the trends in the stock market, fintech may be the most unloved right now. Two fintech darlings, Block (SQ 2.20%) (formerly known as Square) and PayPal, have had horrendous years, even if their businesses are doing alright.
Because the market isn't in touch with how these companies are doing, the fintech space looks like an attractive area to invest in. Read on to find out why Block looks attractive now and if the stock is right for you.
Block's business continues to impress
Block changed its name from Square to indicate to investors that it wasn't just a two-sided business made up of its Cash App and Square payment processing business. Now, it's also heavily involved with Bitcoin, which gives the business a third dimension. Because the company buys Bitcoin for its investors on the Cash App and sells it when asked, this transaction shows up as revenue on the income statement. As a result, management wants users to focus more on gross profit, as it provides a more accurate picture of how the business is doing.
Most people are familiar with Square's card-reading product that small businesses can use to process credit or debit transactions. While this product was primarily used in the U.S. just a few years ago, management's focus on global expansion has worked out, as revenue and gross profits have substantially risen over the past few years.
| Time Period | Square's Gross Profit in Markets Outside the U.S. |
|---|---|
| Q2 2020 | $17 million |
| Q2 2021 | $48 million |
| Q2 2022 | $115 million |
| Q2 2023 | $141 million |
Data source: Block. Chart by author.
Overall, Square ecosystem's revenue rose 12% year over year to $1.93 billion, while gross profit was up 18%. While Square isn't the growth machine it used to be, it's still posting respectable results.
The Cash App is a primary competitor to PayPal's Venmo and can also be used to buy stocks or crypto on the platform. It continues to grow strongly, as peer-to-peer volumes were up 18% in Q2.
But what it's doing within the app is also impressive. In Q2, revenue rose 36% year over year to $3.56 billion, including a 37% rise in gross profit to $968 million. This impressive performance is just one of the reasons Block's stock sentiment isn't in line with actual performance.
So it's clear Block's business is doing quite well. But why isn't the stock responding?
The stock's biggest issue is its lack of profitability
One of the biggest areas investors have concerns with is Block's lack of profits. If you look at Block's quarterly operating margin, it has managed to break even just a few times as a public company.
SQ Operating Margin (Quarterly) data by YCharts
Unlike many of its tech peers, Block has bucked the trend and hasn't laid off any employees. As a result, Block's operating expenses continue to rise quickly, up 19% year over year. That's less than its gross profit grew (up 27% year over year), so its losses narrowed slightly in Q2.
That trend is also expected to continue in Q3. Management expects its stock-based compensation to rise in Q3, but it raised its adjusted operating income (which doesn't include stock-based compensation) guidance for 2023 from a $115 million loss to a $25 million profit.
This is a positive trend, yet Block's stock is valued near an all-time low.
SQ PS Ratio data by YCharts
While the stock doesn't deserve to be valued in the range it traded at during 2021, 1.9 times sales is just too low. At its peak, Block achieved an 8% profit margin. Should the company regain that profitability level, the stock would be valued at 24 times earnings.
Once again, that's if it can get back to those levels. But with the business growth Block is experiencing, it's only a matter of time before Block's full profitability returns. As a result, buying this unloved stock, if you're willing to hold it for at least three to five years, is an excellent plan for any growth-oriented investor.
