Is Block Inc. (SQ) a Good Investment? Payments company Block (SQ) posted solid growth in revenue, gross profit, and adjusted EPS in the first quarter of 2023, beating analysts' expectations. Despite better-than-expected revenue and earnings, investors have...

Payments company Block (SQ) posted solid growth in revenue, gross profit, and adjusted EPS in the first quarter of 2023, beating analysts' expectations. Despite better-than-expected revenue and earnings, investors have been bearish about the stock amid Cash App's fraud allegations. Let's find out if it is wise to invest in this stock. Continue reading….

Tech conglomerate Block Inc. (SQ) reported fourth-quarter revenue, gross profit, and earnings that topped Wall Street's expectations. While the company delivered solid top-to-bottom line growth, fraud allegations against its payment platform, Cash App, dampened investor sentiment surrounding the stock.

Given SQ's lackluster profitability, elevated valuation, a challenging macro environment, and controversy over the Cash App business, this tech stock is best avoided now. I have discussed several reasons why I am extremely bearish on this stock.

With a $37.20 billion market cap, SQ creates tools that enable sellers to accept card payments and provides reporting and analytics, and next-day settlement. The company's main product is Square, a payments platform allowing small and medium businesses to accept credit card payments. It offers commerce products, including Cash App, Spiral, TIDAL, and TBD.

The tech company reported fiscal 2023 first-quarter revenue and earnings that surpassed Wall Street estimates. SQ's net revenue increased 26% year-over-year to $4.99 billion. First-quarter revenue topped analysts' expectations of $4.60 billion. Also, the company's gross profit was $1.71 billion, surpassing estimates of 1.65 billion.

In addition, the company's adjusted EPS for the quarter came in at $0.04, an increase of 122% year-over-year and beating analyst estimates of $0.35.

SQ stock failed to benefit from revenue and earnings coming in above analysts' estimates amid allegations of scams on its peer-to-peer payment app, Cash App. In March 2023, Hindenburg Research, a short seller investment firm, alleged in a new report that SQ had misrepresented to investors the number of people using Cash App's platform and the costs of acquiring them.

Hinderburg said, "Former employees estimated that 40% - 75% of accounts they reviewed were fake, involved in fraud, or were additional accounts tied to a single individual."

Also, the firm alleged that users made transactions through Cash App for illegal activity and allowed crime and fraud. The accusation triggered a Securities Exchange Commission (SEC) investigation. SQ's stock has been hit hard after the news of Cash App's fraud practices came out.

Shares of SQ have slumped 11.1% over the past six months and 24.9% over the past year to close the last trading session at $61.50.

Here is what could shape SQ's performance in the near term:

Solid Financials

For the first quarter that ended March 31, 2023, SQ's total net revenue increased 26% year-over-year to $4.99 billion, while its bitcoin revenue came in at $2.16 billion, up 25% from the prior-year period. The company's gross profit rose 32.4% year-over-year to $1.71 billion.

Furthermore, the company's adjusted net income and adjusted net income per share came in at $252.10 million and $0.40, up 143.1% and 122.2% year-over-year, respectively.

Favorable Analyst Estimates

Analysts expect SQ's EPS for the fiscal year (ending December 2023) to come in at $1.71, representing an increase of 70.7% year-over-year. The consensus revenue estimate of $20.72 billion for the ongoing year indicates an 18.2% year-over-year increase. Moreover, the company has surpassed the consensus revenue estimates in each of the trailing four quarters.

In addition, the company's EPS and revenue for the fiscal year 2024 are expected to rise 40.4% and 13.6% year-over-year to $2.40 and $23.53 billion, respectively.

Stretched Valuation

In terms of forward non-GAAP P/E, SQ is trading at 36.04x, 328% higher than the industry average of 8.42x. Likewise, the stock's forward EV/EBITDA and Price/Cash Flow multiples of 26.52 and 24.28 compare unfavorably with the industry averages of 10.43 and 9.84, respectively.

Low Profitability

SQ's trailing-12-month gross profit margin of 34.94% is 40.7% lower than the industry average of 58.91%. The stock's trailing-12-month EBITDA and net income margins of negative 0.32% and 1.90%, compared to the respective industry averages of 20.60% and 25.80%. Also, its trailing-12-month levered FCF margin of 1.40% is 90.7% lower than the 15.16%.

Furthermore, SQ's trailing-12-month ROCE, ROTC, and ROTA of negative 2.03%, negative 1.15%, and negative 1.13% compare to the industry averages of 11.10%, 5.21%, and 1.12%, respectively.

POWR Ratings Reflect Bleak Prospects

SQ has an overall D rating, translating to a Sell in our POWR Ratings system. The POWR Ratings are calculated by considering 118 distinct factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. SQ has a D grade for Quality, in sync with lower-than-industry profitability. In addition, it has a D grade for Stability. The stock's 24-month beta of 2.46 justifies the Stability grade.

SQ is ranked #79 of 101 stocks in the D-rated Financial Services (Enterprise) industry.

Beyond what I have stated above, we have also given SQ grades for Growth, Value, and Momentum. Get all SQ's POWR Ratings here.

Bottom Line

Payments company SQ delivered better-than-expected revenue and earnings in the first quarter of fiscal 2023. Despite revenue and adjusted EPS coming in above analyst estimates, SQ's stock took a hit in recent months amid controversy over the Cash App business. Activist short seller Hindenburg alleged that SQ inflated its customer growth, allowed fake accounts, and dodged revenue regulations.

Given SQ's poor profitability, lower-than-industry valuation, high stock price volatility, and bleak growth prospects amid controversy around Cash App's platform, it could be wise to avoid this financial services stock for now.

Stocks to Consider Instead of Block, Inc. (SQ)

The odds of SQ outperforming in the weeks and months ahead are greatly compromised. However, there are many industry peers with impressive POWR Ratings. Thus, consider these three stocks, which are either A-rated (Strong Buy) or B-rated (Buy):

Jiayin Group Inc. (JFIN)

CPI Card Group Inc. (PMTS)

Medallion Financial Corp. (MFIN)

What To Do Next?

Get your hands on this special report with 3 low priced companies with tremendous upside potential even in today's volatile markets:

3 Stocks to DOUBLE This Year >

SQ shares rose $0.15 (+0.24%) in premarket trading Friday. Year-to-date, SQ has declined -2.69%, versus a 11.22% rise in the benchmark S&P 500 index during the same period.

About the Author: Mangeet Kaur Bouns

Mangeet's keen interest in the stock market led her to become an investment researcher and financial journalist. Using her fundamental approach to analyzing stocks, Mangeet's looks to help retail investors understand the underlying factors before making investment decisions.

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