1 Turnaround Growth Stock to Buy Before It Soars 505%, According to Cathie Wood’s Ark Invest

In September 2020, Cathie Wood’s Ark Invest estimated that fintech company Block (SQ -0.34%) would reach $375 per share by 2025. That implied 150% upside at the time, but Block stock has since declined by more than 50%. The target now implies 505% upside from the current price of $62 per share.

That drawdown notwithstanding, Wood and her team seem just as bullish today as they were back then. Block is currently the fourth-largest position in Ark’s portfolio, accounting for 5.4% of invested assets. In September 2020, Block was the fifth-largest position in Ark’s portfolio, accounting for 5.6% of invested assets.

Is Block the turnaround story Ark believes it to be?

Block simplifies commerce and consumer finance

Block breaks its business into two product ecosystems. The Square ecosystem comprises hardware, software, and banking services to support merchants across physical and digital sales channels. The cohesive nature of the Square ecosystem differentiates it from the disjointed payment processing options traditionally offered to small and medium-sized businesses by merchant service providers.

Similarly, Cash App lets users save, spend, borrow, and invest money from a single platform. The comprehensive nature of the ecosystem simplifies consumer finance, and that value proposition is resonating with the market. Cash App was the ninth-most downloaded mobile application in the U.S. last year, and the most downloaded financial application.

Block reported first-quarter financial results that beat expectations on the top and bottom lines. Total gross profit increased 22% to $2 billion, reflecting 25% growth in Cash App and 19% growth in Square. Meanwhile, non-GAAP net income soared 98% to $0.85 per diluted share. Ecosystem-specific updates are discussed below.

Square: Block made progress on monetizing larger sellers and international sellers. Mid-market sellers, defined as merchants with at least $500,000 in annualized gross payment volume (GPV), accounted for 39% of Square GPV in the first quarter, up from 38% in the prior year. Additionally, international sellers accounted for 13% of Square gross profit, up from 11% in the prior year.

However, total Square GPV increased just 9% in the first quarter, a material deceleration from 17% growth in the prior year. That led to sluggish transaction revenue growth of 9%. But that was offset by 29% growth in subscription and services revenue, driven by banking products like Square Loans and Square Debit Card.

Cash App: Block is drawing more consumers to Cash App and engaging them to a greater degree. Monthly transacting users increase 6% to 57 million in the first quarter, and inflows per monthly transacting user increase 11% to $1,255, a sequential acceleration from 8% growth in the fourth quarter. That’s encouraging because Block’s near-term focus is “driving paycheck deposit adoption and increasing inflows per active” to establish Cash App as its users’ primary bank.

Importantly, the number of Cash App Card users increased 20% to 24 million in the first quarter, while buy now pay later volume increased 25% versus the prior year and Cash App Pay volume increased 40% versus the prior quarter. Those metrics show deeper engagement across Cash App’s portfolio of financial services.

Reconciling Ark’s valuation model with the current reality

In September 2020, Ark Invest estimated that Block would reach $375 per share by 2025. That prediction was overly ambitious in hindsight for a variety of reasons, which can be summed up as (1) Ark expected gross profit to grow more quickly and (2) Ark expected the market to afford Block a higher valuation.

To elaborate, the price target was based on trailing-12-month (TTM) gross profit increasing at 53% annually to reach $15.7 billion by the fourth quarter of 2025. But TTM gross profit has only compounded at 40% annually to $7.9 billion through the first quarter of 2024. For Ark to be correct, Block would need to double its TTM gross profit in the next seven quarters, which implies a significant acceleration.

Even if that happens, there is another problem. Ark’s price target of $375 per share implies a market capitalization of $182 billion, which itself implies a valuation of 11.6 times gross profit. But investors are being far less generous with the stock than Ark anticipated. Block currently trades at 4.9 times gross profit.

Block could turn things around and beat the market

Block traded at $150 per share when Ark published its valuation model. Its share price has since declined 57% while the S&P 500 (^GSPC -0.04%) has advanced 64%. But the stock could be a turnaround story from here.

Block has captured less than 5% of what management believes is $205 billion addressable market as measured in gross profit. Wall Street expects the company to grow earnings per share at 41% annually over the next three to five years. That consensus estimate makes the current valuation of 78.7 times earnings seem relatively reasonable.

Additionally, Block’s current price-to-gross-profit multiple of 4.9 is a material discount to the three-year average of 11.6. From that price, this fintech stock could beat the market over the next three to five years.