As tech heavyweights battle it out in the global payments space in 2024, Zip Co Ltd (ASX: ZIP) shares have exploded on the chart.
They are up more than 400% at the time of writing, outshining all the major equity benchmarks in doing so, after a 17% gain in the last month alone.
Zip and payments competitor Block Inc (ASX: SQ2) are two heavyweights in the buy now, pay later (BNPL) space.
Both companies attract analyst attention and draw plenty of headlines. Block made waves in 2022 when it acquired BNPL pioneer Afterpay for $29 billion in stock.
But which one of these payment titans comes out on top in profitability? Let's dive into the numbers.
Profit versus profitability
Before running the numbers on Block and Zip shares, it's important to know there's a distinction between "profit" and "profitability". The former is an accounting term that refers to the gross, operating, or net profit earned by a business.
We also won't be referring to growth here in this analysis, which differs from profitability.
Revenues minus all costs, interest and taxes equals net profit. The percentage of net profit to revenue is the net profit margin.
Profitability, on the other hand, is an economic term that measures the efficiency and efficacy of a company's business assets.
Measures of profit and profitability are intertwined like the helix of our DNA and, in many ways, represent the genomic profile of the company as an organism.
We want to know two things. One, how much a business needed to invest to produce a dollar of sales and profits.
Two, what the rate of return on these investments was. Here, we are looking at how much is earned relative to the assets (otherwise known as capital) required to produce the profits.
Two useful measures of profitability are return on equity (ROE) and return on invested capital (ROIC). The former is net income relative to net assets but can be distorted by debt and other non-cash charges.
ROIC removes the effects of financial leverage and allows for useful comparisons between companies. It shows how much profit was earned on the capital invested in a business.
Let's move on to how this applies to Block and Zip shares.
Block and Zip shares comparison
Now that we've got that sorted let's crunch the numbers. When it comes to profitability metrics, Zip shares are in second place in most measures. For the trailing 12 months, Zip reported an ROIC of 8.7% on an operating margin of 26%.
But it produced a free cash flow (FCF) margin of 34%, meaning that underneath every dollar of revenues was 34 cents of cash.
Meanwhile, Block operates on a far thinner operating margin of 4% for the last twelve months, but produced sales of US$23.8 billion vs. Zip's US$283 million (at current exchange rates).
Block's FCF margin for the last 12 months was also 6%, well behind Zip. But whilst Zip has more free cash left over as a function of sales, what it does next with that cash is paramount.
In fact, Block may be slightly ahead in this regard. In the trailing twelve months, it produced a 22% ROIC on its Square Loans business, while its Afterpay and CashBorrow divisions earned 34% and 33% ROIC, respectively.
That means for every $1 of capital that's been invested into Block's operations, it is returning more than 22 cents – 34 cents in profit.
Compare this to Zip, which is returning 8.7 cents on the same dollar invested into its business. This is a key distinction between Block and Zip shares.
You might wonder how Zip can have higher operating margins and FCF margins, but Block is more 'profitable' when looking at returns on capital.
Without getting too jiggy with it, it boils down to Block's higher sales volume and the fact that Block has had more opportunities to grow.
For instance, Zip has reduced its capital base by US$1.7 billion since FY21, whereas Block has grown its capital base by nearly US$3.7 billion.
So, even though Zip has a higher FCF margin, Block appears to use more of the cash it produces to reinvest and grow the business.
This is critical when thinking about profitability over time for both Block and Zip shares.
Who wins in the profitability stakes?
Both Zip and Block have delivered commendable results, but Zip edges out Block in terms of margins, with its 34% FCF margin and 26% operating margin standing out.
However, profitability looks at business returns, and on this front, Block is the most profitable company right now.
Time will tell what happens from here.
