1 Magnificent Growth Stock to Buy Before It Soars 550%, According to Cathie Wood's Ark Invest

In September 2020, Cathie Wood’s Ark Invest published an open-source valuation model for Block (SQ 0.90%), which is available for download through GitHub. The model outlines a few scenarios, but the base case prices Block at $375 per share in 2025, implying a 550% upside from its current price.

Here’s what investors should know.

Wall Street is worried about third-quarter guidance

Block topped expectations on the top and bottom lines in the second quarter, though shares still slipped as much as 14% following the report because Wall Street found guidance disappointing. Total gross profit increased 27% to $1.9 billion on strong results in the Cash App ecosystem, and non-GAAP (non-generally accepted accounting principles) income soared 117% to $0.39 per diluted share. But gross profit growth declined to 21% in July, and management expects growth to hold steady at that level throughout the third quarter.

Looking ahead, management estimates its U.S. market opportunity at $190 billion in gross profit, a projection that includes $120 billion from the Square ecosystem and $70 billion from the Cash App ecosystem.

Block is making progress with Square and Cash App

The investment thesis for Block centers on its ability to simplify commerce for sellers and finance for consumers. Specifically, the Square ecosystem eliminates complex integrations with a cohesive suite of hardware, software, and financial services that make it easy for merchants to engage in omnichannel commerce.

Similarly, the Cash App ecosystem allows users to deposit, borrow, send, spend, and invest money from a single platform. And it does so while incurring much lower costs than traditional financial institutions.

In the Square ecosystem, Block sees expansion opportunities with mid-market merchants (i.e., those with annual sales exceeding $500,000) and international merchants, and it made progress in both areas during the second quarter. Mid-market merchants accounted for 40% of gross payment volume, up from 39% one year ago and 35% two years ago. Meanwhile, international merchants accounted for 16% of Square gross profit, up from 15% one year ago and 8% two years ago.

Cash App is also moving in the right direction. It was the most downloaded digital wallet in the U.S. in 2022, and monthly active users (MAUs) reached 54 million in June, up 15% from the prior year. But Cash App’s gross profit climbed 37% in the quarter ended in June, signaling that gross profit per MAU is rising. That means Block is monetizing the Cash App ecosystem more effectively, and investors have reason to think that trend might continue.

Block recently partnered with Stripe and Adyen to make Cash App Pay a checkout option for their merchants, and it’s making Cash App Pay accessible to more Afterpay merchants. So what? Cash App becomes more valuable to users as its acceptance network expands, so an uptick in merchant adoption should bring more consumers to the digital wallet. That network effect could be a powerful tailwind if it gains momentum.

Ark’s valuation model runs into trouble

As mentioned, Ark published an open-source valuation model for Block about three years ago. The firm outlines a scenario in which the stock trades at $375 per share by 2025, implying a 550% upside in the interim. That price target is based on several assumptions, and two of the most important are listed below:

  • Square ecosystem revenue will increase by 19% annually through 2025.
  • The Cash App ecosystem will achieve 75 million MAUs by 2025.

Those assumptions are reasonable. Square ecosystem revenue rose just 13% in the first half of 2023, but it rose at 38% annually between 2020 and 2022, compensating for the more recent shortfall. Additionally, Cash App ecosystem MAUs would need to increase by 14% annually to reach 75 million by 2025, which seems plausible, given that MAUs increased 15% in the last year.

But Ark runs into trouble with its next wave of assumptions, which deal with monetization and valuation. Specifically, the firm believes gross profit could hit $15.7 billion in 2025, but that implies annual growth of 40% over the next 10 quarters, a material acceleration from 27% growth in the second quarter.

Additionally, Ark assumes Block will trade at 11.6 times gross profit in 2025, but the stock trades at 5.2 times gross profit today, meaning investors are unwilling to pay such a high multiple at present. That may change if growth accelerates, but readers will recall that management is actually forecasting a deceleration in gross profit growth in the current quarter.

Block is a worthy investment, but don’t expect 550% returns

Ark deserves praise for making its valuation model open source. Few Wall Street institutions provide that type of transparency to the general public. That said, I doubt Block shareholders will return anywhere close to 550% by 2025, but the stock is still worth buying.

Block is taking sensible steps to expand the Square and Cash App ecosystems, and its $190 billion market opportunity leaves plenty of room for future growth. Additionally, its current valuation of 5.2 times gross profit is well below the three-year average of 18.5 times gross profit. That’s why investors should feel comfortable buying a small position in this growth stock today.

Source link

About The Author

Scroll to Top