Cathie Wood is the founder and CEO of Ark Invest, an asset management firm that invests in innovative companies and disruptive technologies. The firm offers several exchange-traded funds to clients, including its flagship Ark Innovation ETF, which has returned 39% year to date. But the Ark Fintech Innovation ETF is up 49% this year, and the firm is leaning into those gains.
Throughout August, Ark trimmed its holdings in Tesla -- though it remains the portfolio's largest position -- and redeployed capital across several fintech companies, including Block (SQ 2.32%) and Adyen (ADYE.Y -1.57%). In terms of asset allocation, Block currently ranks no. 6 and Adyen ranks no. 51 out of 125 total holdings.
Here's what investors should know about these two growth stocks.
1. Block
Block breaks its business into two product ecosystems: Square for merchants and Cash App for consumers. The Square ecosystem simplifies commerce by bundling hardware, software, and financial services into a cohesive platform. That end-to-end strategy eliminates complex integrations, and it initially helped Block gain momentum with micro-merchants, though the company is now pushing upmarket.
Meanwhile, the Cash App ecosystem simplifies consumer finance by allowing users to borrow, send, spend, and invest money from a single interface, and it offers that functionality while incurring much lower costs than traditional banks. So what? Cash App can serve users that would be unprofitable for many financial institutions, and each new user amplifies the network effect created by its peer-to-peer capabilities. That flywheel has undoubtedly contributed to swift adoption. Cash App was the most downloaded digital wallet among U.S. consumers in 2022.
Block delivered sound financial results in the second quarter. Total gross profit climbed 27% to $1.9 billion, reflecting 18% growth in Square and 37% growth in Cash App, and non-GAAP income soared 117% to $0.39 per diluted share. Management does expect gross profit growth to slip a few percentage points in the current quarter, but the investment thesis remains solid.
Block values its addressable market at $190 billion in gross profit, including $120 billion from Square and $70 billion from Cash App, and the company is taking sensible steps to gain share in both ecosystems. For instance, Block has built a robust arsenal of business software and banking services over the years that go beyond payment processing. Those products are bringing bigger sellers to Square, while also improving overall retention rates.
Similarly, Block recently made Cash App Pay available to Stripe and Adyen merchants, a gambit that serves a dual purpose: It gives Block another means of monetizing payments beyond Square, and it enhances the Cash App value proposition for consumers (which could boost adoption) by expanding merchant acceptance.
On that note, shares of Block currently trade at 5.2 times gross profit, an absolute bargain to the five-year average of 18.9. Investors should feel comfortable buying a few shares of this fintech stock today.
2. Adyen
Block undoubtedly simplifies commerce, but payment processors are not the only piece of the puzzle. To accept electronic payments, merchants also need an acquirer. When a consumer uses a card at checkout, the processor routes an authorization request to the issuing bank through the appropriate card network, and the acquirer settles the transaction by moving funds from the issuer to the merchant.
European payments company Adyen integrates processing and acquiring capabilities on a single platform that supports electronic payments across physical and digital channels in 100 countries. That strategy gives Adyen access to more robust data than stand-alone processors or acquirers, and it uses that data to boost authorization rates and prevent fraud for its merchants. That compelling proposition has helped the company land big clients like McDonald's, Netflix, and Spotify.
Adyen is also an attractive partner for marketplaces like Etsy and Uber because its platform includes embedded financial services that allow businesses to create bank accounts, issue cards, and send payouts to their own customers. Suffice it to say Adyen has distinguished itself by providing a broad range of capabilities. Indeed, management says it is "the only company that can offer a global integrated payments stack across channels through a single platform."
Adyen delivered a mediocre financial performance in the first half of the year. Revenue rose 21% to 739 million euros, well short of the 40% growth forecast by analysts, and net income was flat at 282 million euros due to significant headcount expansion. But investors responded with a heavy hand as the stock slipped 40% following the report.
That seems like an overreaction, especially when management reiterated its expectation that revenue would grow "between the mid-twenties and low-thirties in the medium term" in the latest shareholder letter. That growth trajectory makes its current valuation of 4.3 times sales look quite cheap. In fact, shares have not been cheaper at any point in the last three years. Investors should consider buying a small position in this growth stock now.
