Over the past eighteen months, shares in Cash App and Square parent Block (NYSE:SQ) have fallen in price by around 75%. With this, many investors may believe that the worst is already priced-in with SQ stock.
But while Block’s valuation is a lot more reasonable today than it was in late 2021, don’t assume that it has become a bargain. As I have argued previously, it’s possible that the market is too confident in the fintech firm’s growth prospects.
This is because of growing odds of a severe economic downturn later this year. I’m not the only one holding this cautious view on SQ right now. Just recently, a sell-side analyst (more below) laid out a similar bearish argument.
A challenging economic environment could affect Block’s various businesses across-the-board. If this scenario plays out, shares could sustain further declines before (possibly) embarking on a recovery.
| SQ | Block | $58.94 |
SQ Stock and the Latest Analyst Downgrade
Earlier this month, Square released its latest quarterly results. As you may recall, right after the earnings release, I argued that there was more cause for concern than cause for celebration with these latest numbers.
To some extent, the sell-side community’s positive sentiment for SQ stock has been damped since the May 4 earnings release. Several analysts have made downward revisions to their respective price targets in recent weeks. Still, one analyst has made the leap, from being bullish on Block, to becoming bearish on it.
That would be CLSA’s John Marrin. On May 11, he downgraded SQ from “buy” to “underperform.” While coming on the heels of recent earnings, Marrin’s argument for the downgrade focused less on the latest results, and more on what could play out in the coming quarters.
As hinted above, Marrin believes that the chances of a “hard landing” for the U.S. economy during the latter half of 2023 keeps rising, as high inflation and interest rates squeeze consumers and small businesses.
Alongside downgrading Block stock, Marrin has also lowered his price target from $93 to $63 per share. However, I believe that even this target (modestly above current prices) may be too optimistic.
How a ‘Hard Landing’ Could Really Chop Block
The argument that this company could struggle during a tough recession is not a new revelation. Since late 2021, SQ stock investors have been bracing for the impact of a recession. Not only that, some segments of Block could prove to be more resilient than the aforementioned bearish analyst commentary suggests.
Namely, Cash App. Last year, some commentators argued this segment could keep thriving because it was connected more to essential purchases than on discretionary ones. Thus far, this appears to be playing out. Cash App continues to experience above-average levels of revenue and gross profit growth, despite the in-progress economic slowdown.
Even so, this gross profit growth has yet to translate into a swing from net losses to net profits for the overall company. That’s not all.
Cash App’s growth may also fail to counter the potential hit an economic “hard landing” could create for Block’s two other major segments, Square and Afterpay. Square of course could experience decreased merchant transaction volumes if the economy contracts.
Earlier this month, I pointed out that Afterpay, a “buy now, pay later” service, could end up reporting far greater loss rates, if economic conditions become more challenging.
Bottom Line: Stay Away as the Bear Case Strengthens
If Block’s revenue growth screeches to a halt, and net losses make a big leap higher, forget about SQ merely treading water at or near present price levels (high-$50s per share).
A worsening of the overall economic backdrop may just well be enough to push the stock back to multi-year lows (around $40 per share) before the stock truly bottoms out.
Even if a “hard landing” is averted, Block could remain under pressure. A “soft landing” could still lead to worse numbers than the figures the company has recently reported.
Potential increased regulatory scrutiny following short-seller allegations last March, is something else that may keep weighing on shares.
With shares now perhaps at greater risk of experience yet another plunge, consider it best to keep skipping out on SQ stock.
SQ stock earns a D rating in Portfolio Grader.
On the date of publication, neither Louis Navellier nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.