Following years of incredible price gains, Block (SQ 2.32%) shares have been in the doldrums. After peaking in 2021, the shares are now 66% off of their highs. That includes a 27% rise in 2023, just a tad more than the S&P 500.
At its previous highs, Block stock was exchanging hands at an astronomical valuation. It's now trading at just over 2 times trailing-12-month sales. But that's only a bargain if there's an exciting future ahead for Block. Let's see where to expect it to be next year at this time.
Where did Block go wrong?
Block's original business was its small, square-shaped card reader that could attach to a smartphone and process credit card transactions for sellers. (The product, called Square, was also the company's original name.) At the time, that was serious tech. Today, it has continued to compete in what's now a crowded fintech industry chock-full of new technological advances all the time.
However, there's always risk with new, growth-oriented companies. In Block's case, it's facing plenty of competition in all of its segments from big players like Shopify, which now offers many services that directly compete with the Square sellers business, and SoFi Technologies, which provides many of the same services as Block's Cash App.
The company also focused intensely on blockchain technology and Bitcoin, to the extent that these influenced a change in its name and its stated trajectory, and this new direction has added a level of volatility to the business. Block counts Bitcoin trading as revenue, and at times, Bitcoin trading has contributed extreme increases or decreases to the total. In the third quarter of 2023, Cash App revenue climbed 34% year over year, but rose only 26% excluding Bitcoin.
Block has been reporting increasing revenue, with more strength in the Cash App segment than the merchant business. But it hasn't posted a profit -- even an operating profit -- in two years.
SQ Net Income (Quarterly) data by YCharts
Block likes to measure its progress by gross profit, which increased 21% year over year in the third quarter to $1.9 billion. However, gross margin was 33.8%, well below pre-pandemic levels. Operating expenses were $1.91 billion in Q3, up 18% versus the prior-year period and exceeding gross profit.
Growth drivers in 2024
Despite some quirks, Block has a strong business. The Square sellers segment is growing by double-digit percentages, and Block is strengthening the platform with generative artificial intelligence (AI) services and contactless payments.
Cash App is consistently the top payment app in the Apple store, and it holds the same position in the Piper Sandler "Taking Stock With Teens" survey. Block has expanded it into a full-service financial app with bank accounts and investing. It acquired buy now, pay later (BNPL) company Afterpay in 2021, and says the BNPL specialist contributed $129 million in revenue and $94 million in gross profit in the third quarter.
Chief Executive Officer Jack Dorsey said in Block's Q3 shareholder letter that the enhanced Cash App sits between the intersection of peer-to-peer payments, financial services, and commerce, and that the company would leverage this combination to create a new business category. He envisions highlighting the commerce aspect and bringing the seller and Cash App ecosystems together for a stronger overall platform that Block can leverage into a larger business.
Will things improve next year?
Block is a Cathie Wood favorite, and the spirit of innovation that Wood loves has led to the incredible growth the company has demonstrated for several years. It's been stuck a bit in combining that strong spirit with its origins as a supplier of real value solutions for small businesses, but it's clear that clients really like Block's services.
Management says it has penetrated 5% of what it sees as a $200 billion addressable market, and that it will launch new products to reach new markets. However, Block's bigger problem is using its resources efficiently and slashing expenses.
In a year from now, the best-case scenario is that Block's revenue, market, and client base are growing while it focuses on cost efficiency. It looks like management is on board with that plan, and that it's moving past its focus on cryptocurrency while doubling down on its popular core services.
Block has done that in the past, profitably, so there's reason for optimism. However, it's taken a detour and needs to prove itself again, so there's risk. Right now, I wouldn't recommend the stock unless you have an appetite for risk and a long-term investing horizon. But if you do, Block is starting to look more interesting.
