What happened
Shares of Block (SQ -5.08%) dropped 28.4% last month, according to S&P Global Market Intelligence. Investors soured on the stock after it’s quarterly results were released. The stock also struggled with a sell-off in cryptocurrency markets.
So what
Block reported quarterly earnings early in August, and those results were met with mixed reviews. The company modestly outperformed analyst estimates and revised its full-year forecasts higher. Block is targeting international markets to stimulate growth, and it is pulling back on hiring plans to control costs. These factors combined to deliver better-than-expected operating performance.
Image source: Getty Images.
Despite reporting those generally favorable results, the stock dropped following the announcement. Investors are worried that Block will struggle against growth headwinds in the medium term. A difficult environment for consumers is bad news for small business transaction volumes, which will negatively impact transaction fee revenue for Block’s Square payment solutions. Consumer weakness and volatile capital markets are also likely to dampen demand for the company’s Cash App services, which include personal banking, transfers, payments, and investing tools.
Block shares also rise and fall with the performance of Bitcoin (BTC -0.37%) for better or worse. The company owns a significant amount of the cryptocurrency, and it generates a portion of its gross profit from cryptocurrency transactions. In reality, crypto assets are a relatively small proportion of the company’s balance sheet, and Bitcoin transactions only represented 2% of its gross profit last quarter. Investors seem to overreact to the true fundamental impact of crypto fluctuations on the company’s performance, but Block’s reputation as a blockchain leader has established a clear association with Bitcoin in the minds of investors. After the earnings sell-off, Block continued to struggle as Bitcoin slid lower.
SQ data by YCharts.
Now what
Like many growth stocks, Block’s valuation may have gotten out of control during the COVID-19 bull market. Share-price rationalization was probably unavoidable, but the stock is worth a look now that it’s down more than 75% from its all-time high.
The company continues to execute, with growth profit continuing to charge higher. It managed to reduce operating losses over the first half of the year, and it generated more than $400 million of operating cash flow over the past two quarters. Excluding the impact of Bitcoin revenue, which is volatile and doesn’t contribute much to the bottom line, the company’s first-half revenue rose 23% over last year’s.
SQ Gross Profit (TTM) data by YCharts.
Block will remain volatile and correlated to Bitcoin, which creates risk for investors. However, the underlying fundamentals have to matter for investors at some point. The company’s share prices are trending down, while its fundamentals keep improving. There are likely challenges to growth over the next few years, but the stock is available at a forward price-to-earnings (P/E) ratio below 40. That’s an enticing valuation for bullish investors, given Block’s medium-term growth potential.
Ryan Downie has positions in Block. The Motley Fool has positions in and recommends Bitcoin and Block. The Motley Fool has a disclosure policy.
