Look around you, and you'll quickly see many trends shaping the global economy. A popular tailwind that continues to power the world forward is the proliferation of digital payments. And Block (SQ 2.32%) is a business that is at the forefront of this push.
Despite its disruptive potential, the fintech stock has been a letdown for investors. It's down 20% in the last 12 months (as of Feb. 2), which is discouraging given the Nasdaq Composite index has risen 32% during that time.
It's time to remain optimistic and have a contrarian perspective. Here's why investors should take a closer look at Block shares as a smart portfolio addition.
Competitive positioning
In my opinion, it's always a great idea to limit the businesses you buy to those that have competitive advantages. This way, they are better protected from rival firms and new entrants. And their business models can't be easily replicated from the constant threat of disruption.
I believe that Block has these characteristics. It's clear if we look at both of the company's key segments independently.
Square makes money from the transactions that its merchants handle, as payment processing is a key feature it offers. Of course, this is dependent on gross payment volume (GPV), which totaled $55.7 billion in Q3 2023.
But Square also offers various add-on subscriptions and services that generate recurring revenue. And this leads to high switching costs for merchants that get familiar with operating their businesses with Square as a mission-critical software provider.
There might also be switching costs for Cash App customers. Once consumers start to handle basic banking and financial needs, like setting up direct deposit or buying stocks with a single provider, it's unlikely they will need to change to another company's services if things work smoothly.
The leadership team is trying to find ways to better integrate Cash App and Square to create a stronger ecosystem. Should progress be made on this front, it could result in powerful network effects for the overall business. Having a higher number of merchants as Square customers could make it more compelling to become a Cash App user because there are more places to spend and possibly more incentives and rewards. And with more Cash App users out there, merchants might find more value in becoming a Square customer because there are more shoppers to target.
Even management thinks the stock is cheap
The fact that the stock is currently 76% below its peak price distracts investors from the fact that Block is still growing at a rapid clip. Gross profit increased 21% year over year for the overall company, with both of the major segments reporting double-digit gains. And the leadership team expects adjusted operating income to more than quadruple between 2023 and 2024, thanks to ongoing cost-optimization efforts.
There are lots of untapped opportunities on the table. For example, Square has huge potential in international markets, which represented 17% of its GPV in the third quarter, a share that is quickly rising. And with Cash App, there's the opportunity to get more users to sign up for the Cash App Card, which currently has a 40% penetration rate.
All of these positive factors lead to the conclusion that the stock is probably undervalued right now. Shares trade at a price-to-sales multiple of just under 2, a substantial discount to its historical average.
The management team recently announced a $1 billion share repurchase authorization. So, even the executives likely view the stock as being cheap these days, and they want to take advantage.
Investors who adopt a long-term time horizon, with the intention to hold stocks for five to 10 years, should look to buy Block today.
