Block, Inc. (NYSE:SQ) stock has outperformed the S&P 500 (SPX) since I upgraded SQ in late May, seeing an opportunity to get more constructive. SQ was initially hampered by negative sentiment relating to the short attack by Hindenburg Research.
However, SQ investors have shrugged off the attack, as they bought the dips in mid-May, bolstering its recent recovery. Despite that, I assessed that momentum buyers will not likely return until SQ regains its medium-term uptrend decisively. As such, I believe the opportunities to get on board SQ’s nascent recovery remain intact as investors fret over its exposure to SMBs and lower-income consumers.
Moreover, the US economy has proven to be more resilient than economists had anticipated. I shared in a recent Invesco QQQ ETF (QQQ) article how the consensus view of economists about a recession had shifted to one where “no recession [is] coming after all.”
With the market pricing in a more hawkish Fed, given the strength of the recent jobs numbers and the US economy, SQ’s outperformance augurs well. It likely suggests that market operators could have priced in the worst at its lows in October 2022.
Block management updated in a recent conference and reminded investors that it’s making progress in moving upmarket. Despite that, “regulatory constraints as a financial institution limit Block’s ability to act like an internet company.” As such, it’s critical for investors to assess Block’s ability to outgrow its industry peers, given the growth premium baked into its valuation.
CFO Amrita Ahuja articulated that the company is attacking a $200B TAM, in which its opportunity is still nascent. Ahuja stressed that the company’s penetration of less than 5% indicates that Block can continue to “take share over time.”
I believe that’s the crux of the company’s thesis in a highly competitive financial technology space. With its legacy banking peers on schedule to launch FedNow in late July, the competitiveness against Block will likely intensify. The leading banks are fighting back with their massive resources and their stocks trade at much lower valuation multiples than SQ. As such, investors need to assess the dynamism in the competitive landscape on how Block’s edge could be impacted.
Morningstar rated Block with a narrow economic moat, corroborating its strength in the SMB segment. In addition, investors are also reminded that the monetization opportunities in its consumer-facing Cash App “may be limited.”
However, I gleaned that management thinks that the monetization opportunity within Cash App is still early, as it focuses on “product adoption and engagement within the ecosystem.” As such, investors must assess the underlying growth in “product attachments and inflows per active over time.”
Wall Street analysts’ estimates suggest that Block’s growth opportunities are still in the earlier stages. Analysts project the company could gain significant operating leverage over the next few years.
Accordingly, Block’s adjusted EBITDA is estimated to increase at a CAGR of more than 35% from FY22-25. Seeking Alpha’s Quant also rated SQ’s growth metrics with an “A+” grade (the best possible).
Therefore, I believe it’s important to assess SQ from a growth stock perspective on whether its valuation has reflected its potential bottom-line growth over the next three years.
SQ last traded at an FY25 EBITDA multiple of 16.5x, which is still above its peers’ forward median of 10.7x (according to S&P Cap IQ data). As such, bears could argue that SQ’s valuation has likely baked in a high level of optimism, suggesting that CEO Jack Dorsey and his team must execute impeccably to achieve its growth projections.
I believe SQ’s growth premium remains its most significant risk in my thesis, and investors considering adding more positions must have a high conviction over the company’s ability to gain share.
SQ price chart (weekly) (TradingView)
Note that SQ formed its lows in October 2022, and buyers defended it stoutly in March and May, refusing to allow sellers the opportunity to take out lower lows.
I assessed that SQ’s recovery momentum indicates that dip buyers are increasingly confident, as seen in its buying sentiment in May. In addition, SQ could retake its medium-term uptrend bias, even though it’s still too early to ascertain when that would occur.
Still, I gleaned that high-conviction investors who have confidence that SQ could recover further from its May lows should find the current levels appealing.
While a pullback should be expected with SQ’s momentum in overbought levels, I’m more confident that SQ could see further upside from here as momentum investors could return to bolster its upward re-rating.
With that in mind, I believe it’s time to turn even more constructive on SQ and not wait for these investors to arrive first so that we can get in earlier.
Rating: Strong Buy. (Revised from Buy).
Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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