💎 Fintech's Hidden Gem. SQ Stock Analysis
A comprehensive analysis of Block (SQ), Jack Dorsey's fintech powerhouse: innovative ecosystems, a narrow economic moat, and potential undervaluation.
💡 Investing Thesis
Block Inc. (NYSE: SQ) emerges as a compelling investment opportunity in the rapidly evolving fintech sector. My focus on Block is driven by its substantial growth potential, operating in a massive addressable market with current penetration below 5%. The company's emerging economic moat, built on network effects and intangible assets, positions it favorably against competitors.
Under the visionary leadership of Jack Dorsey, Block continues to innovate, particularly in cryptocurrency integration, potentially providing a significant competitive edge. Current valuation metrics, including a PEG ratio of 0.82, suggest the stock may be undervalued relative to its historical levels and growth prospects.
While risks such as regulatory challenges and competition exist, Block's innovative approach to financial services, combined with its growth trajectory and attractive valuation, presents an opportunity for investors seeking exposure to the dynamic fintech landscape. Stock trading at 2018 levels. The rise of Bitcoin.
🧐 Company Overview
Block Inc., formerly known as Square, has established itself as a prominent player in the financial technology sector since its founding in 2009 by Jack Dorsey and Jim McKelvey. The company's journey began with introducing its iconic square-shaped card reader, which revolutionized point-of-sale systems for small businesses. Over the years, Block has significantly expanded its product offerings, evolving into a multifaceted financial services platform.
Today, the company operates two primary ecosystems: Square, which caters to sellers and businesses, and Cash App, a peer-to-peer payment and financial services app for consumers. Block's innovative approach to financial technology has led to impressive growth, with its revenue skyrocketing from modest beginnings to a substantial $9.6 billion in 2023.
📰 To Read: What you can learn from how Jack Dorsey leads
At the helm of Block is co-founder and CEO Jack Dorsey, who also co-founded and previously led Twitter. Dorsey's dual role as CEO of both Block and Twitter (until November 2021) has been a subject of discussion among investors and industry observers. His leadership style and vision have played a crucial role in shaping Block's strategy and corporate culture. Dorsey is known for his focus on innovation, user experience, and long-term thinking, which has influenced Block's approach to product development and market expansion.
Under Dorsey's leadership, Block has strongly emphasised financial inclusion and democratizing access to financial services. This philosophy is evident in the company's efforts to serve underbanked populations and small businesses that larger financial institutions have traditionally overlooked. Dorsey's interest in cryptocurrency, particularly Bitcoin, has also influenced Block's strategy, leading to integrating Bitcoin trading and investment features within the Cash App ecosystem.
🏰 Economic Moat Overview
Block has established a narrow economic moat, primarily rooted in its network effects and intangible assets. The company's Square ecosystem benefits from a two-sided network effect, where an increase in sellers using the platform attracts more buyers, and vice versa. This dynamic creates a virtuous cycle that enhances the value of the platform for all participants. Additionally, Block's Cash App has developed its network effect among consumers, as its utility increases with each new user joining the platform.
📰 To Read: About Square
The company's brand recognition and technological innovations serve as intangible assets that further strengthen its competitive position. Block's ability to maintain double-digit sales growth every year since its inception, despite facing significant competition, underscores the strength of its economic moat.
However, the rapidly evolving nature of the financial technology sector and the presence of competitors prevent Block from achieving a wide-moat status at this time.
🚀 Business Strategy
Block's business strategy revolves around three key pillars: ecosystem expansion, product innovation, and international growth. The company aims to create a comprehensive financial services ecosystem that seamlessly integrates various products and services for both businesses and consumers. By continuously expanding its product offerings within the Square and Cash App ecosystems, Block seeks to increase user engagement and drive cross-selling opportunities.
Product innovation remains at the core of Block's strategy, with the company investing heavily in research and development to stay ahead of market trends and customer needs. This focus on innovation has led to the introduction of new features and services, such as Bitcoin trading and stock investing within the Cash App.
International expansion represents another crucial aspect of Block's strategy, as the company seeks to replicate its success in new markets. By tailoring its products and services to meet local needs and regulatory requirements, Block aims to capture a larger share of the global financial technology market.
💰 Profit Drivers
Block's profitability is driven by several key factors that contribute to its financial success. The company's ability to monetize its user base through various revenue streams plays a crucial role in driving profits. For the Square ecosystem, transaction-based revenue from payment processing fees forms a significant portion of the company's income. As Block expands its seller base and processes higher transaction volumes, this revenue stream is expected to grow.
Strong year-over-year gross profit growth and 22% YoY Growth:
Subscription and services-based revenue, which includes products like Square Capital and Cash Card, represents another important profit driver. These higher-margin offerings not only generate recurring revenue but also enhance user stickiness within Block's ecosystems.
The Cash App's diversified revenue model, including instant deposit fees, Bitcoin trading, and the Cash Card, contributes to the company's overall profitability. Block's focus on operational efficiency and scalability also plays a role in driving profits, as the company leverages its technology infrastructure to support growth while managing costs.
✅ Advantages
Block possesses several key advantages that position it favorably in the competitive financial technology landscape. The company's strong brand recognition and reputation for innovation give it an edge in attracting and retaining users across both its Square and Cash App ecosystems. Block's integrated approach to financial services, offering a wide range of products within a single platform, provides a seamless user experience that sets it apart from traditional financial institutions and standalone fintech solutions.
The company's data-driven insights and machine learning capabilities enable it to continually improve its products and services, enhancing user satisfaction and driving adoption. Block's first-mover advantage in certain areas, such as mobile point-of-sale systems for small businesses, has allowed it to establish a strong market position.
The company's robust financial position, with a substantial cash reserve, provides it with the flexibility to invest in growth initiatives and weather economic uncertainties.
❌ Disadvantages
Despite its strong market position, Block faces several challenges and potential disadvantages. The highly competitive nature of the financial technology sector poses a constant threat, with numerous established players and emerging startups vying for market share. Block's reliance on payment processing fees as a significant revenue source exposes it to potential margin pressure as competition intensifies and merchants gain bargaining power.
The company's expansion into new product areas, such as Bitcoin trading and stock investing, introduces additional regulatory complexities and potential risks. Block's dual-class share structure, which gives co-founder and CEO Jack Dorsey significant voting control, may raise corporate governance concerns among some investors.
The company's ongoing investments in growth initiatives and new product development could impact short-term profitability, potentially testing investor patience. Additionally, Block's exposure to the volatile cryptocurrency market through its Bitcoin holdings and trading services introduces an element of unpredictability to its financial results.
🏛️ Capital Allocation
Block's capital allocation strategy reflects a focus on long-term growth and innovation. The company prioritizes reinvesting in its business to drive organic growth, with significant expenditures directed towards research and development, sales and marketing, and technology infrastructure. Block has also pursued strategic acquisitions to expand its capabilities and market reach.
Notable acquisitions include the $29 billion all-stock deal for Afterpay, an Australian buy-now-pay-later platform, in January 2022. This acquisition aims to strengthen the synergies between Block's Square and Cash App ecosystems by integrating Afterpay's services.
An interesting aspect of Block's capital management is its approach to share issuance and buybacks. The company regularly increases its shares outstanding through stock-based compensation and stock-based acquisitions, which are crucial for attracting and retaining top talent and funding expansion.
Simultaneously, Block conducts share buybacks to offset dilution and return capital to shareholders when it believes its stock is undervalued. Despite these buybacks, the total number of shares outstanding has generally increased over time, reflecting the company's prioritization of growth and acquisition strategies.
💲Current Valuation
Block's current valuation metrics show a decrease compared to recent years. The current Enterprise Value of $37.11B is lower than its value of $43.71B a year ago and well below the 5-year average of $42.33B, indicating a substantial drop in the company's market value. The Trailing P/E ratio has decreased from 146.83 in 2021 to 86.39 currently, suggesting the stock is less expensive relative to its past earnings. The Forward P/E has declined from 72.20 in 2021 to 20.48, implying improved future earnings expectations relative to the stock price, and is now below the 5-year average of 52.34. The Price/Sales ratio has fallen from 5.23 in 2021 to 1.84, showing the stock is significantly cheaper relative to its sales and below the 5-year average of 3.34. The Price/Cash Flow ratio has decreased from 92.57 in 2021 to 52.84, now slightly below the 5-year average of 58.09.
These metrics suggest Block is currently valued more conservatively compared to its recent historical levels and 5-year averages. The most important thing is that the current PEG ratio is only 0.82.
📈 Past and Future
Block's past performance shows significant underperformance compared to its industry and the broader market index. Over the past year, SQ returned -3.12%, lagging behind the industry's 27.16% gain. The 3-year and 5-year CAGR performances are negative, while the industry showed strong positive returns. Short-term performance has also been challenging, with substantial declines over 3 and 6-month periods.
Despite this recent underperformance, analyst estimates a more optimistic future. Sales are projected to grow from $25.11 billion (expected) in FY 2024 to $30.56 billion in FY 2026, with annual growth rates declining from 14.55% to 9.43% over this period. Earnings per share are expected to see significant improvement, with projected growth of 90.62% in FY 2024, followed by 27.22% and 22.77% in the subsequent years. As we can see, expectations for 2024 are very high.
1-year stock price forecast:
These estimates suggest analysts anticipate Block to have strong profitability growth, potentially reversing the negative trend seen in recent years.
🥇 Competitors
Block operates in a highly competitive landscape, facing rivalry from both traditional financial institutions and innovative fintech companies. In the payment processing space, Block competes with established players like PayPal, Stripe, and Adyen, as well as traditional merchant acquirers and banks. These competitors often have significant financial resources and established merchant relationships, posing a challenge to Block's market share growth.
In the peer-to-peer payments arena, Cash App faces competition from Venmo (owned by PayPal), Zelle (backed by major U.S. banks), and emerging digital wallet providers. Tech giants like Apple and Google also represent potential threats as they expand their financial services offerings.
📰 To Read: Cash App Pay Integrates with Google Play, Giving Next Gen Consumers More Choice at Checkout
In the small business lending segment, Block competes with online lenders such as OnDeck and Kabbage, as well as traditional banks. The buy-now-pay-later market, which Block entered through its Afterpay acquisition, is increasingly competitive, with players like Affirm and Klarna vying for market share. Block's ability to innovate, leverage its existing user base, and provide a seamless, integrated experience across its ecosystems will be crucial in maintaining its competitive edge in this dynamic landscape.
👉 Other
Became profitable this year. Block's Q1 was the company's best quarter ever.
Bitcoin Initiative: Block has made significant investments in Bitcoin. In the fourth quarter of 2023, Block reported $2.5 billion in Bitcoin revenue.
Block's Hardware Innovations: Square Register and Square Terminal. These products showcase the company's commitment to creating integrated solutions for businesses of all sizes.
Square Banking: In 2023, Block launched Square Banking, offering small business banking services.
ESG Initiatives: Block has made commitments to sustainability and social responsibility.
Spiral and TBD: Block has two subsidiaries focused on Bitcoin and decentralized finance - Spiral (formerly Square Crypto) and TBD. These initiatives demonstrate Block's commitment to pushing the boundaries of financial technology.
Tidal Acquisition: In 2021, Block acquired a majority stake in Tidal, the music streaming platform. This unexpected move into the entertainment industry could be explored as part of Block's diversification strategy.
📊 Market Trends
The data from Blosk's presentation reveals substantial growth opportunities for both Cash App and Square:
Cash App shows a $75 billion gross profit opportunity in the U.S. market for 2023, spread across Community (P2P) services, Financial Services, and Bitcoin trading. Square's ecosystem presents an even larger $130 billion global opportunity, encompassing U.S. Commerce, U.S. Banking, and International markets.
Both platforms have significantly expanded their addressable markets since 2015, with current penetration at less than 5%. This low penetration rate, combined with the growing market sizes, indicates considerable potential for future growth. As Block continues to innovate and expand its offerings, it's well-positioned to capture a larger share of these multi-billion dollar opportunities in fintech and digital financial services.
☑️ Checklist
Profitability:
❌ Gross margin at least 40%: 34.46%
❌ Net margin at least 10%: 1.68%
❌ Management (ROIC, ROCE, ROE, ROA): No (All below 10%)
❌ Piotroski F-Score: 5 of 9 (Not passed: CFROA > ROA, Higher Current Ratio YoY, Less Shares Outstanding YoY, Higher Gross Margin YoY)
✅ Revenue surprises: Yes (All previous years and quarters)
❌ EPS surprises: No
❌ EPS growth YoY: No
Valuation and Advantage:
✅ Valuation below its 5-Yr average: Yes
✅ Does it have a moat: Yes (narrow)
Shares:
✅ Insider ownership at least 5%: Yes
❌ Less shares outstanding YoY: No
❌ Insider sells last three months: Yes ($21.20M)
Price:
✅ 1-year stock price forecast: +37.22%
✅ Next 5-Yr CAGR is above S&P 500: Yes (59.27% vs 11.65%)
✅ DCF Value: $75 (Undervalued 11%)
✅ Short Interest below 5%: 2.25%
This is not a financial or investing recommendation. It is solely for educational purposes.