Shares of Jack Dorsey’s fintech firm Block (NYSE:SQ) have been attempting to form a bottom for nearly a year now. Despite climbing nearly 40% off its 2022 lows, the stock remains down nearly 75% off its all-time highs. Undoubtedly, it’s going to take a lot more to sustain a rebound. Currently, the market environment remains incredibly hostile to innovators that aren’t making a profit or are barely in the green. With SVB Financial’s (NASDAQ:SIVB) Silicon Valley Bank failing this week, matters have gone from bad to worse for the fallen tech innovators that are now licking their wounds.
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The relief rally enjoyed by broader markets saw battered tech stocks leading the way. As rate hike fears and bank jitters cause a reversal, many bottom catchers who jumped in a few months ago could be most at risk. In any case, investors shouldn’t focus on macro factors outside their control. Markets have likely already factored in the potential pressures from rate hikes. At these depths, I believe it’s safe to look to the fallen innovators that can keep up the pace of innovation, even as credit becomes harder to come by.
Undoubtedly, cost cuts and all the sort can be expected from tech firms big and small. Whether such efforts are enough to stage a continuation of a relief rally remains to be seen. In any case, Block seems like a fintech juggernaut that will be left standing as higher rates and a fading economy continue to weigh heavily on the broader tech sector. At the end of the day, Block is still innovating. The market just wants to see such less-than-profitable innovators be more deliberate about how they spend.
At these depths, I do think the risk/reward for Block is the best it’s been in a long time, though it’s unclear whether the $50 range is the bottom.
A top innovator even as the tech scene gets rocky
It’s become harder to value companies like Block that are at the forefront of innovation. Sales growth may no longer cut it for investors afraid that the Federal Reserve will keep raising the bar on rates. Higher rates incentivize profitable growth and more conservative spending practices. Still, sales growth and innovation matter. Tech companies that are aggressively slashing budgets and cutting projects just because the economy stinks could risk falling behind the pack.
Higher rates have raised the stakes for the most innovative companies. However, there are still considerable longer-term rewards to consider for companies (even those that aren’t yet profitable) that can allocate capital effectively.
This high-rate environment is hurting a lot of innovators, but it seems to be hitting the smaller-cap and startup companies a tad harder. The Silicon Valley Bank failure is an existential crisis for many new companies. If nobody comes to the rescue, a lot of smaller innovators may very well bite the dust as their payrolls become challenged.
As startup fintechs feel the pinch and are forced to cut projects to the bone, financially-sound innovators may see the tides flow in their favor. Relative behemoths like Block can be less reactive to economic developments and continue the pace of innovation en route to business that (hopefully) could be wildly profitable in the future.
More growth and innovation are right around the block
Block’s feeling the heat of macro headwinds, with gross payment volumes rising just 15% in its latest quarter. With a looming recession, expectations for growth still seem quite modest. With management planning to trim away at discretionary spending, Block is still in a spot to stay on its feet as tides continue moving through the tech sector.
Chief financial officer Amrita Ahuja remarked on Block’s “incredibly disciplined” approach to “operating expense growth,” though it is worth noting that Block still plans to hire in 2023, albeit at a slower rate. Indeed, Block is still in growth mode, as its large-cap and small-cap peers continue to conduct layoffs.
As a $42.75 billion behemoth, Block is a force to be reckoned with in fintech. Its financial strength remains quite sound, with around $5.6 billion in cash and shorter-duration securities, and just $4.1 billion in long-term debt as of the end of last year. As the company continues to commit cash to improve Cash App, Square and some of its smaller cryptocurrency projects, I do view the Block ecosystem as relatively robust.
Final thoughts
Difficult economic times will pass, and when they do, I believe Block will be ready with a continuously-improved platform, ready to capitalize on the next economic upswing.
Until then, Block investors need to be patient. The company has shown it’s not willing to slash costs just to appease Mr. Market. Block’s in it for the long haul, and it’s still a top innovator. There’s a reason why innovation investor Catherine Wood (Trades, Portfolio) continues to be bullish on the name amid trying times.
Trading at just 2.5 times sales, investors are getting a lot of innovation for a fairly modest price tag. Block isn’t out of the woods yet, but I find it hard to bet against Wood or Dorsey even at these depths.
This article first appeared on GuruFocus.
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