Should You Buy Block Stocks While They’re Below $70?

Block (SQ 2.69%) investors have had a rough couple of years, with the stock down more than 75% from its highs set in August 2021. With the stock down so far, investors who are bullish on Block may wonder if the stock is in bullish territory value at recent prices under $70.

Let’s look at some things investors should consider when determining whether they should buy Block stock at today’s prices.

Block owns two main businesses

Block operates two main businesses. One is its original namesake, Square, which was created to allow merchants to accept card payments from their smartphones or tablets. The business has evolved over the years, and Square now offers more than 30 software and hardware solutions to help merchants run their business.

The company is looking to grow this part of its business by continuing to improve its product suite and accelerate the integration process. Foodservice, a key early market, is still a priority, with the company recently partnering with the distributor US food as well as improving its ordering system to help companies reduce labor costs, reduce wait times and improve order accuracy. Finally, they are looking to expand the business internationally.

Block also operates the Cash app, which is best known as a peer-to-peer payment network. Cash App also offers services such as savings accounts, brokerage accounts, crypto services, debit cards, loans and tax preparation.

On the Cash app side of the business, the company is looking to drive growth in direct deposits by offering additional benefits to customers as well as through increased marketing. Some of the benefits they plan to offer include a high-yield savings account, free overdraft fees, free withdrawals from in-network ATMs and early access to salary.

The company also has two emerging businesses involved in Bitcoin and music. The company sees Bitcoin mining as an opportunity and has developed its own Bitcoin mining chip. He recently signed an agreement with Scientific core to provide you with the new chip.

The company is focused on profitable growth

In recent years, Block has shifted its focus from revenue growth to more profitable growth. It aims to reach the “Rule of 40” value by 2026.

The 40 Rule, made famous as a way to evaluate early-stage software-as-a-service (SaaS) companies, is typically achieved when the combination of revenue growth and profit margin is 40% or more. Because Block’s revenue growth is skewed by its Bitcoin trading business, it uses gross profit growth — which in its case seems more appropriate — and adjusted operating margin. Adjusted operating income excludes interest income, taxes, one-time expenses and some non-cash amortization items.

In Q2, it achieved gross profit growth of 20% and adjusted operating margins of 18%, so it is closing in on that 40% target. It is now forecast to be 35% for the full year, up from previous guidance of 32%. This consists of gross profit growth of over 18% and operating margins of at least 16%.

Right now, it looks like the company could hit its Rule 40 goal a year early.

Image source: Getty Images

High stock compensation remains a problem but is improving

One problem with Block was the high level of stock-based compensation. This is payment to employees in the form of stock. Many companies exclude stock-based compensation from their adjusted earnings, and free cash flow usually doesn’t count because it’s a non-cash expense. However, it is a real expense that can dilute shareholders and affect capital allocation decisions if companies use their cash to buy back shares and mitigate the impact of dilution.

Block, for its part, had $320.4 million in stock-based compensation in Q2, which represented 42% of adjusted EBITDA (earnings before interest, taxes, depreciation and amortization). However, one can also see the progress the company has made in terms of profitability, as a year ago compensation of $319.2 million in stock represented 83% of EBITDA of $384.3 million.

It’s also worth noting that Block includes stock-based compensation in adjusted operating income, which it uses in the Rule 40 calculation. However, it’s excluded in the adjusted EPS number.

The stock’s valuation is attractive

Trading at a forward price-to-earnings (P/E) ratio below 15 times analysts’ estimates for next year’s earnings, Block stock looks very attractive for a nice growth company that’s becoming increasingly profitable. However, factoring in the stock-based compensation adjustment to its adjusted EPS, it’s not as attractive. It would likely be closer to estimates of 26.5 times forward earnings if stock compensation were included in adjusted EPS. That’s still attractive given gross profit and earnings growth, but it’s not the bargain valuation the P/E number suggests.

SQ PE Ratio (1 year ago) data by YCharts

That said, given its growth and valuation, I’d be a buyer of Block below $70 as this fintech company heads toward the Rule 40 target.