One of the biggest losers as of today's evening session is software company Block, whose shares are down -5.0%, underperforming the Nasdaq by -4.0%.
At $43.17, SQ is 43.47% below its average analyst target price of $76.37.
The average analyst rating for the stock is buy. SQ lagged -5.0% behind the S&P 500 index today, and by -38.0% over the last year, returning -16.0%.
Block, Inc., together with its subsidiaries, creates tools that enables sellers to accept card payments and provides reporting and analytics, and next-day settlement. The company is a technology company. Valuations in the technology sector are often very high, as investors are willing to overlook gaps in the fundamentals if they believe a company’s innovations can dominate or create new markets.
Block does not release its trailing 12 month P/E ratio since its earnings per share of $-0.4 are negative over the last year. But we can calculate it ourselves, which gives us a trailing P/E ratio for SQ of -107.9. Based on the company's positive earnings guidance of $2.36, the stock has a forward P/E ratio of 18.3. The average trailing Price to Earnings (P/E) ratio of US-based technology companies is 27.16 as of first quarter of 2023. In contrast, the S&P 500 average is 15.97. The P/E ratio is the company's share price divided by its earnings per share. In other words, it represents how much investors are willing to spend for each dollar of the company's earnings (revenues minus the cost of goods sold, taxes, and overhead).
The main limitation with P/E ratios is that they don't take into account the growth of earnings. This means that a company with a higher than average P/E ratio may still be undervalued if it has high projected earnings growth. Conversely, a company with a low P/E ratio may not present a good value proposition if its projected earnings are stagnant.
When we divide Block's P/E ratio by its projected 5 year earnings growth rate, we obtain its Price to Earnings Growth (PEG) ratio of 0.44. Since a PEG ratio of 1 or less may indicate that the company's valuation is proportionate to its growth potential, we see here that investors are undervaluing SQ's growth potential .
To understand a company's long term business prospects, we must consider its gross profit margins, which is the ratio of its gross profits to its revenues. A wider gross profit margin indicates that a company may have a competitive advantage, as it is free to keep its product prices high relative to their cost. After looking at its annual reports, we obtained the following information on SQ's margins:
| Date Reported | Revenue ($ k) | Cost of Revenue ($ k) | Gross Margins (%) | YoY Growth (%) |
|---|---|---|---|---|
| 2023-02-23 | 17,531,587 | -11,539,695 | 34 | 36.0 |
| 2022-02-24 | 17,661,203 | -13,241,380 | 25 | -10.71 |
| 2021-02-23 | 9,497,578 | -6,764,169 | 28 | -30.0 |
| 2020-02-26 | 4,713,500 | -2,823,815 | 40 | 0.0 |
| 2019-02-27 | 3,298,177 | -1,994,477 | 40 | 5.26 |
| 2018-02-27 | 2,214,253 | -1,374,947 | 38 |
- Average gross margin: 34.2%
- Average gross margin growth rate: 0.1%
- Coefficient of variability (higher numbers indicating more instability): 18.7%
We can see from the above that Block business is not strong and its stock is likely not suitable for conservative investors.
Another key to assessing a company's health is to look at its free cash flow, which is calculated on the basis of its total cash flow from operating activities minus its capital expenditures. Capital expenditures are the costs of maintaining fixed assets such as land, buildings, and equipment. From Block's last four annual reports, we are able to obtain the following rundown of its free cash flow:
| Date Reported | Cash Flow from Operations ($ k) | Capital expenditures ($ k) | Free Cash Flow ($ k) | YoY Growth (%) |
|---|---|---|---|---|
| 2023-02-23 | 175,903 | -170,815 | 346,718 | -64.7 |
| 2022-02-24 | 847,830 | -134,320 | 982,150 | 215.28 |
| 2021-02-23 | 173,110 | -138,402 | 311,512 | 285.52 |
| 2020-02-26 | 327,630 | 246,826 | 80,804 | -77.42 |
| 2019-02-27 | 295,080 | -62,787 | 357,867 | 132.67 |
| 2018-02-27 | 127,711 | -26,097 | 153,808 |
- Average free cash flow: $372.14 Million
- Average free cash flow growth rate: 0.0%
- Coefficient of variability (the lower the better): 389683878.9%
Free cash flows represents the amount of money that is available for reinvesting in the business, or paying out to investors in the form of a dividend. With a positive cash flow as of the last fiscal year, SQ is in a position to do either -- which can encourage more investors to place their capital in the company.
Another valuation metric for analyzing a stock is its Price to Book (P/B) Ratio, which consists in its share price divided by its book value per share. The book value refers to the present liquidation value of the company, as if it sold all of its assets and paid off all debts. As of the first quarter of 2023, the average P/B ratio for technology companies is 6.23. In contrast, the average P/B ratio of the S&P 500 is 2.95. Block's P/B ratio is 1.48, telling us that the market value of the company exceeds its book value by a factor of 1, but is still below the average P/B ratio of the Technology sector.
As of first quarter of 2023, Block is likely fairly valued because it has a negative P/E ratio, a lower P/B ratio than its sector average, and irregular cash flows with a flat trend. The stock has poor growth indicators because of its weak operating margins with a negative growth trend, and a negative PEG ratio. We hope this analysis will inspire you to do your own research into SQ's fundamental values -- especially their trends over time.
