Block, Inc. (SQ): A Good Undervalued Stock to Invest In Now
We recently compiled a list of the 16 Most Undervalued Stocks to Buy Now. In this article, we are going to take a look at where Block, Inc. (NYSE:SQ) stands against the other undervalued stocks.
With the US stock market touching record highs, mainly driven by significant contributions from big technology sectors, domestic and global investors continue to observe market dynamics to tap potential opportunities. Therefore, identifying undervalued stocks becomes important as they might provide substantial value amidst high valuations across sectors.
Concentration of S&P 500
Courtesy of “Magnificent 7” stocks that captured investor attention in 2024, the market cap concentration in the leading US equities is the highest in decades. Strategists at Goldman Sachs believe the 10 largest US stocks now constitute ~33% of the S&P 500 index’s market value. This is well above the ~27% share reached at the peak of the tech bubble which was seen in 2000.
The present concentration helped in driving a period of strong US market returns. The market saw an annualized total return of ~16% over the previous 5 years. This compares to the 30-year annual average of 10%. As per Goldman Sachs, the top 10 stocks made up for over a third of that gain. That being said, “today’s top stocks are trading at lower valuations than the largest stocks did at the peak of the tech bubble in 2000.”
Despite healthy returns, investors are anxious regarding the extreme current degree of market concentration relative to the recent history.
There appear to be similarities between the current conditions today and the episodes in 1973 and 2000. The labor market seems to be in a decent state, and concentration has been rising along with robust equity market returns. In these episodes, the peak of equity market concentration also led to the peak of a bull market, and the US economy saw recessionary fears in the subsequent year.
However, the 1964 experience reflects that an ongoing bull market might continue to move higher despite a decline in market concentration. After the market concentration peaked, stock prices and the US economy were resilient for an extended period.
Are The US Stocks Overvalued or Undervalued?
The valuations of the largest stocks are well below the previous highs. As of now, the 10 largest stocks continue to trade at the collective forward P/E multiple of ~25x, well below the peak valuations seen in the largest stocks in 2000, 2020, and the middle of 2023.
The valuations are also lower based on the premium the largest stocks are trading at relative to the rest of the market. That is to say that the ~35% valuation premium today remains well below the 80% premium seen in the middle of 2023 and the 100% premium of 2000. Though the degree of market cap concentration is indeed higher today as compared to the peak touched in 2000, the largest stocks are trading at much lower multiples than during the technology bubble.
Our methodology
We used the Finviz screener to extract the list of 16 Most Undervalued Stocks to Buy Now. We have shortlisted the stocks that are expected to report earnings growth this year and have a forward P/E multiple of less than ~21.66x (as the market trades at the forward multiple of ~21.66x). We ranked the stocks in ascending order of their hedge fund sentiment.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (see more details here).
People using the Cash App paying for goods and services, highlighting the impact the of the company's payment tools.
Block, Inc. (NYSE:SQ)
Forward P/E as of August 22: 18.94x
Number of Hedge Fund Holders: 59
Expected EPS Growth this Year: 100%
Block, Inc. (NYSE:SQ) provides payment services to merchants and related services. It also launched Cash App, a person-to-person payment network.
Block, Inc. (NYSE:SQ) targets to be on the growth path. The company’s “Rule of 40” by 2026 plan places the bar high, with gross profit and adjusted operating income targets set at ~15% and ~25% (the sum equates to 40%), respectively. Adjusted EBITDA margin of the company increased from 17% in 2020 to reach 24% in 2023.
Block, Inc. (NYSE:SQ) anticipates that figure to increase to 33% this year, with the company focusing on cutting costs instead of increasing sales. The management anticipates a combined total addressable market (based on gross profit) of $190 billion between Square and Cash App. It will utilize its typical playbook to attract customers and boost usage via the introduction of new product features and expansion in new markets.
Block, Inc. (NYSE:SQ) is expected to benefit from switching costs. The merchants who lean on Square mission-critical partners are somewhat locked in the ecosystem. Also, consumers handling basic banking needs through Cash App don’t feel like changing the providers. Apart from switching costs, the company’s network effects are also expected to drive growth. Its ecosystem has features for every business, from point-of-sale to financial support.
Analysts at Citigroup upped their price objective on shares of Block, Inc. (NYSE:SQ) from $86.00 to $90.00. They gave a “Buy” rating on 6th May. In Q2 2024, there were 59 hedge fund holders in the company.
Baron Funds, an investment management company, released its second-quarter 2024 investor letter. Here is what the fund said:
“Block, Inc. (NYSE:SQ) provides point-of-sale technology to small businesses and operates the Cash App ecosystem of financial services for individuals. Shares gave back gains from earlier this year despite reporting strong quarterly results and raising full-year guidance. In the first quarter, gross profit grew 22% and EBITDA grew 91%, both exceeding Street expectations. Given the strong start to the year, second-quarter guidance of 16% to 17% gross profit growth may have disappointed some investors. Management remains committed to a “Rule of 40” investment framework in 2026 with at least mid-teens gross profit growth and a mid-20% operating margin. We continue to own the stock due to Block’s long runway for growth, durable competitive advantages, and innovative product offering.”
Overall SQ ranks 8th on our list of the most undervalued stocks to buy. While we acknowledge the potential of SQ as an investment, our conviction lies in the belief that some deeply undervalued AI stocks hold greater promise for delivering higher returns, and doing so within a shorter timeframe. If you are looking for a deeply undervalued AI stock that is more promising than SQ but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.
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Disclosure: None. This article is originally published at Insider Monkey.