Lately, the market has been enamored with artificial intelligence stocks, and some other areas have suffered as a result. One of those is fintech, and two of its largest players have had pretty abysmal years. Both Block (SQ 2.32%) and PayPal (PYPL 2.90%) are down over 10% this year yet still have solid results.
Fintech stocks were all the rage on Wall Street a few years ago. Now, they are an afterthought. This usually represents top buying opportunities as other investors have strayed from no-brainer investments like Block and PayPal. That's exactly what I see, but there are a few things to be aware of before taking a position in these two.
1. Block
Block, formerly known as Square, divides its company into two operating segments. The first is Square, its business-facing product that provides payment processing and banking services to its clients worldwide. Second is its Cash App, which started as a peer-to-peer payment service and allows users to buy stocks and Bitcoin and do their banking.
Because both of Block's services can have some cryptocurrency impacts, Block wants investors to focus on gross profit or income after product expenses. This is a smart strategy in general for investors, as a company could be growing revenue rapidly but may be subsidizing that growth with lower margins, which will hurt it in the end.
Both Square and Cash App posted solid results in its latest quarter, with gross profit rising 18% to $888 million for Square and 37% to $968 million for Cash App. It may surprise some investors that Cash App is a bigger part of Block's business than how it got started with Square, but it conveys how important this app has become to many users.
Unfortunately, Block's operating expenses have consistently risen, which has kept the company from becoming profitable. Operating expenses rose 19% in the second quarter, which is still less than gross profit growth. This may be the primary holdup, as Block used to post an operating profit just a couple of years ago.
Because Block has proven they could do it once, I'm confident they can do it again. But, the short-term mentality of many investors has caused them to abandon ship on Block stock. As a result, the stock can be purchased at what I see as being an incredibly attractive valuation.
SQ P/S Ratio data by YCharts.
Investors shouldn't expect Block to return to its 10-plus-times sales valuation it achieved from 2018 to 2021, but 1.6 times is almost nothing to pay for a company that has become integrated into the payment infrastructure. Block looks like a screaming buy here, and investors should use the short-term weakness to establish a long-term holding.
2. PayPal
PayPal sits in a slightly different spot in the fintech realm. While it has an app to rival Cash App (Venmo), it also acts as a digital wallet and provides payment processing for some clients through its Braintree product. The main holdup for many investors has been PayPal's slow revenue growth rate. In Q2, PayPal only grew revenue by 7% and expects 8% growth in Q3. That's not much growth for a growth stock, so many investors headed for the exits.
But the problem with that statement is that PayPal isn't a growth stock anymore, per se. Now, it's more like a value stock, as the primary part of its investment thesis has become stock buybacks and earnings growth.
Thanks to easy year-over-year comparisons, PayPal's earnings per share (EPS) have rapidly grown and increased by 414% in Q2. These are permanent gains thanks to operating efficiency improvements and have given PayPal the cash flow to repurchase a lot of stock. Management repurchased about $1.5 billion in stock in Q2, but after subtracting stock-based compensation expenses, this number falls to about $1.1 billion.
During Q2, PayPal had an average market cap of $76 billion, which means PayPal repurchased about 1.5% of the company in a single quarter. That's an incredible repurchase pace and will drive long-term shareholder returns even if PayPal only grows in the high single digits.
But the market hasn't bought into this strategy, and the stock looks dirt cheap by traditional valuation metrics as a result.
PYPL P/E Ratio data by YCharts.
Regardless of whether you use trailing or forward-looking earnings, PayPal's stock has never been this cheap. While the new CEO, Alex Chriss, will have to prove himself, he's been given the keys to a machine practically driving itself.
If PayPal sees any new business success under him, the stock is at such a low starting point it could explode higher at any time. As a result, I think buying PayPal now is a genius investment move.
