The stock market had a weak year in 2022. The S&P 500 was down by about 20% with just over a week to go. Growth stocks were generally hit the hardest thanks to rising interest rates, recession fears, and a general loss of appetite for speculation among investors. Fintech leader Block (SQ 0.49%) — formerly known as Square — was one of the worst large-cap performers, with shares declining by nearly 65%.
Despite its terrible performance, there is still quite a lot to like about Block. Its business continues to grow; it has plenty of future potential; and now the stock is trading for a much more attractive valuation. I’ve been a shareholder since shortly after Block’s initial public offering (IPO), but here’s why I plan to add aggressively to my position in 2023 if the stock stays anywhere near its current level.
Block’s business looks strong
You might not think so based on its stock performance, but Block’s business has been performing quite well. Excluding Bitcoin (BTC -0.05%) transactions (which don’t generate much actual income for the company), Block’s revenue grew by 36% year over year in the third quarter.
In Q3 the company reported 38% year-over-year gross profit growth, including a 51% surge from Cash App. And while the company isn’t consistently profitable yet, that has more to do with the company being in growth mode and reinvesting in its business. Block is rather profitable on an adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) basis, with about $900 million in adjusted profit over the past four quarters.
Cash App now has 49 million monthly active users, and it is doing an excellent job of monetizing them through its various services. For example, 36% of the active user base now uses the Cash App Card for purchases, up from 25% two years ago. Cash App has also ramped up its direct deposit feature, and the platform saw more than $2 billion in direct deposits in September alone.
On the business side of the company’s ecosystem (which is still known as Square), there is now about $200 billion in annualized payment volume.
Lots of room to grow
Not only is Block’s business growing rapidly, but it has plenty of runway ahead of it. On the business side, $200 billion in annualized payment volume might sound enormous (and it is), but there is around $45 trillion in global cashless payment volume. And Cash App is still in the relatively early stages of building out its capabilities; as it adds more products and services, it can cross-sell to nearly 50 million users.
International expansion remains a massive opportunity for the company and one that management takes very seriously. In Q3, 15% of Square’s gross profit came from outside of the U.S., up from just 5% in the comparable period in 2018.
Finally, with $6.5 billion in cash on its balance sheet, Block has the financial flexibility to invest in its growth as opportunities arise.
A fintech leader at a discount
From a valuation perspective, Block looks extremely attractive right now. It trades at a price-to-sales (P/S) multiple of 1.97 — its lowest ever and down from a P/S of more than 15 at its 2021 peak — even though the growth momentum in the business remains strong.
To be sure, there are some major risk factors to watch. Bitcoin hasn’t exactly had a stellar 2022, Block’s recent Afterpay buy-now-pay-later business adds a major element of credit risk, and a slowdown in consumer spending or a recession could hurt Block’s business from all sides. But even with this in mind, the stock looks like an excellent bargain from a risk-reward perspective, and it could be worth a closer look for patient long-term investors.
Matthew Frankel, CFP® has positions in Block and has the following options: short January 2024 $200 calls on Block. The Motley Fool has positions in and recommends Bitcoin and Block. The Motley Fool has a disclosure policy.