What happened
Shares of Square and Cash App parent Block (SQ 5.58%) plunged 23.2% in September, according to data from S&P Global Market Intelligence.
It was a bad month for many technology and financial stocks as long-term interest rates rose sharply. However, Block's month was especially bad because it caught a downgrade from Wall Street analysts while also seeing the CEO of a key business unit step down from her position, adding to the uncertainty.
NYSE: SQ
Key Data Points
So what
The month didn't start off particularly well. UBS analyst Rayna Kumar downgraded Block shares to neutral from buy on Sept. 6. Kumar noted the muted growth in active customers in the second quarter and the prospect for decelerating gross-profit growth as the consumer comes under pressure from higher interest rates.
Things didn't get any better on Sept. 19, when Square unit CEO Alyssa Henry stepped down after nine years on the job. Of note, Square is the "original" business of Block, as the merchant payments processing hardware and software focused on small businesses. Today, the Square business makes up a little less than half of Block's gross profit, with the consumer-focused Cash App ecosystem now the majority.
It wasn't clear what the reason was behind her departure, but management turnover at the C-suite level is usually not great for investor sentiment.
And, of course, the relentless march higher of long-term U.S. Treasury Bond yields put increasing pressure on high-multiple growth stocks such as Block last month as well. All things equal, higher bond yields lower the prices of stocks, especially growth stocks with the bulk of their profit potential far out in the future.
Now what
Block is one of those growth companies that reports "adjusted" profits but still loses money on a generally accepted accounting principles (GAAP) basis when factoring in stock-based compensation. With higher interest rates and a lower stock price -- which makes stock-based compensation more dilutive -- investors are losing patience with these types of stocks. This is especially true of the fintech sector, which is seen as vulnerable to an economic slowdown or recession.
Ironically, it's Block's consumer business that is the current star. Cash App actually saw accelerating gross-profit growth last quarter of 37% relative to the year-ago growth rate of 29%, while the Square business decelerated to 18% growth relative to the same 29% growth in the year-ago quarter.
Amid all the pessimism, Block now trades at roughly 3.7 times its trailing gross profits, which seems kind of cheap for a business growing nearly 30% overall. And the stock is down nearly 50% from its price in late July! In fact, Block's shares now trade around the COVID-19 lows seen in March 2020.
While no one likes to see an important executive leave, Block stock looks like an interesting target for long-term growth investors after its meltdown. But the bull thesis appears to rest on Cash App, not the troubled Square business.
