Should You Buy Block Stock While It’s Below $70?

The stock is more than 75% off its all-time highs. Read More...

The stock is more than 75% off its all-time highs.

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

Let’s look at a few things investors should consider when determining if they should buy Block shares at today’s prices.

Block owns two primary business

Block operates two main business es. One is its original namesake, Square, which was created to let merchants 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 retailers run their business.

The company is looking to grow this part of its business by continuing to enhance its product suite and speed up its onboarding process. Food service, a key early market, is still a priority, with the company recently partnering with distributor US Foods as well as improving its ordering system to help companies lower labor costs, reduce wait times, and improve order accuracy. Finally, it is also looking to expand the business internationally.

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

On the Cash App side of the business, the company is looking to drive direct deposit growth through offering customers added benefits as well as through increased marketing. Some of the benefits it plans on offering include a high-yield savings account, free overdraft fees, free in-network ATM withdrawals, and early paycheck access.

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. It recently signed a deal with Core Scientific to provide it with its new chip.

The company is focusing on profitable growth

In recent years, Block has transitioned its focus from revenue growth to more profitable growth. It has a goal of achieving the “Rule of 40” metric by 2026.

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

In Q2, it achieved gross profit growth of 20% and adjusted operating margins of 18%, so it is getting close to that 40% goal. It is now projecting to be at 35% for the full year, up from prior guidance of 32%. This consists of gross profit growth of over 18% and operating margins of at least 16%.

At this point, it looks like the company could potentially achieve its Rule of 40 goal a year early.

Image source: Getty Images

High stock compensation remains an issue, but is improving

One issue with Block has been its 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 doesn’t usually account for it since it’s a non-cash expense. However, it is a real expense that can dilute shareholders, and it affects capital allocation decisions if companies use their cash to buy back stock and mitigate the impact of dilution.

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

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

The stock’s valuation is attractive

Trading at a forward price-to-earnings (P/E) ratio under 15 times analysts’ earnings estimates for the next year, Block stock looks very attractive for a nicely growing company that is becoming increasingly profitable. However, when taking into consideration the stock-based comp adjustment to its adjusted EPS, it isn’t quite as attractive. It would probably be closer to 26.5 times forward earnings estimates if stock-based comp were included in its adjusted EPS. That’s still attractive given its gross profit and earnings growth, but it’s not the bargain-bin valuation the headline P/E number would suggest.