Why you should buy Block stock (and it's not Bitcoin)

As management emphasizes Bitcoin, more established segments continue to prosper.

a forefinger and thumb hold a small block with a yellow star on it which is being placed next to two of the same blocks so they form a line of three blocks.

Image source: Getty Images

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

The name change of Square to Block (NYSE: SQ) dramatically changed the narrative for the company. Once viewed as a pure fintech stock, it has pivoted to music streaming with Tidal and built a cryptocurrency ecosystem that makes it seem more like a conglomerate.

Consequently, Block's performance has become more closely aligned with that of Bitcoin (CRYPTO: BTC), reinforcing perceptions that it is a different enterprise. Nonetheless, a closer look at the company indicates that Block remains primarily Square and Cash App, and, at least for now, investors have little reason to consider its other ventures while evaluating the stock.

Block stock: Perception vs. reality

The state of Block stock has changed dramatically in a year. Last September, Block (still known as Square at the time) sold for more than $250 per share. Moreover, Jack Dorsey managed both Block and Twitter, Inc.(NYSE: TWTR), and Bitcoin was in a bull market.

Beginning in late November, Dorsey devoted himself to the company full-time, leading to the name change and emphasis on its Bitcoin-based segments, Bitcoin advancement company Spiral and Web platform TBD. Dorsey even predicted that Bitcoin would replace sovereign currencies.

Both Block and Bitcoin subsequently lost most of their value. Admittedly, most tech stocks have fallen, so one cannot blame Block's decline on Dorsey's prognostications. Still, the company's fortunes seem tied to Bitcoin. Since Dorsey became the full-time "Block Head," Block stock declined 65%, while Bitcoin is off 62%.

Unfortunately for Block shareholders, the stock may have fallen victim to a false perception. Technically, Bitcoin made up $3.5 billion of Block's $8.4 billion in revenue in the first half of 2022. However, since the company transacts the cryptocurrency, most of that "revenue" would count as payment volume if the accounting rules differed. After subtracting Bitcoin costs, real Bitcoin revenue amounts to only about $85 million in the first six months of the year, about 3% of gross profits.

The Square and Cash App ecosystems

Thus, instead of worrying about Bitcoin, Block investors should judge the company based on the Square and Cash App ecosystems, which still account for nearly all of the company's revenue. Cash App is a social payments platform that accommodates users' spending, deposits, and investing. Cash App also led the way in Bitcoin trading on its platform when it began trading the cryptocurrency in 2018. With this functionality, it boasts 47 million monthly active users and has beaten PayPal's Venmo for number of downloads on Apple Inc. (NASDAQ: AAPL)'s iPhone, according to MobileAction.

The Square segment also built a successful niche with businesses. The platform can accommodate nearly all of a business's financial needs. This includes transactions, payroll, inventory, point-of-sale, and loans. In the U.S., where it opened an industrial bank, Square can also manage a company's checking and savings accounts.

Additionally, it is moving across the developed world and currently operates in eight countries. Since three of the countries are in the EU, that foothold could mean a relatively easy move into the 24 EU countries it does not yet serve. Also, only $146 million of its gross profit for the first two quarters (around 5%) came from outside the U.S., meaning its non-U.S. markets hold significant potential for growth.

The state of Block stock

Overall, Block reported about $2.8 billion in gross profit in the first two quarters of 2022, growing 31% year over year. Still, operating expenses increased by 68% during that time, leading to a loss for the first half of the year of $417 million. Block earned $243 million in the same period one year ago.

Block's investments in its business may ease concerns about returning to losses. This is crucial, as investors have shown less leeway for money-losing companies in this bear market.

Another consideration is an expensive valuation, as its price-to-free-cash-flow ratio of 70 makes it considerably pricier than PayPal Holdings, Inc.(NASDAQ: PYPL) at 22 times free cash flow. Nonetheless, the aforementioned 31% gross profit growth for the first half of 2022 could help make Block a buy in this bear market due to its still rapid growth.

Admittedly, Bitcoin, Tidal, and other parts of Block may become a more consequential share of gross profits over time. However, considering the bright future of the Square ecosystem and Cash App, Block stock could make a massive comeback with or without its newer segments.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Will Healy has positions in Block, Inc. and PayPal Holdings. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Apple, Bitcoin, Block, Inc., PayPal Holdings, and Twitter. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has recommended the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple. The Motley Fool Australia has positions in and has recommended Block, Inc. The Motley Fool Australia has recommended Apple and PayPal Holdings. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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