Block Stock Slumps Despite Earnings Rising by 65%

Block (NYSE: XYZ) (formerly Square) delivered its second-quarter earnings after the close of trading on Aug. 5, and shares fell by about 6% the next day. Even with a 65% year-over-year jump in adjusted earnings per share, investors focused on weakening growth in the number of Cash App's monthly transacting actives. But the stock's discount may still present an opportunity for patient investors.

Image source: Block.

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AI is driving strong earnings growth

The biggest story of the quarter was the impact of Block's AI-centered strategy on profits. Adjusted earnings came in at $1.02 per share, well above the $0.87 per share consensus estimate. The market may dismiss this as a one-time beat, but the earnings call points to a structural shift in costs that could support higher earnings over time.

In February, Block announced a 40% reduction in its workforce, citing AI tools that are making software engineers more productive, and leading the company to need fewer of them. The number of code changes per engineer is up 150% since the start of the year.

Investors may see this as a temporary margin lift, but management doesn't.

"That way of working ultimately drives improved efficiency over time and greater leverage to our business over time," CFO Amrita Ahuja said. Management expects full-year earnings to grow by 70%.

Those higher profits can be reinvested in developing new products that could help drive long-term revenue growth -- an opportunity that may not be reflected in the stock price.

Why the stock could be undervalued

One reason the stock fell was the weakening growth in Cash App's monthly transacting activities. The number of those active users grew just 3% year over year -- a deceleration from the 4% increase in the previous quarter. Growth has cooled as mobile payments have become more competitive, and management is guiding for low-single-digit percentage growth for the full year.

Still, this is partly by design, as management is prioritizing a strategy of getting more value per user. The earnings power it's seeing from AI-driven efficiency should support that push.

At the same time, other metrics show momentum in key areas of the business. Square's gross payment volume (GPV) growth in the U.S. market accelerated to 10% year over year, with international GPV up 28%. Cash App consumer lending originations rose 59%, and commerce enablement volume grew 17%.

Management also expects its Neighborhoods program, which connects Square sellers with Cash App customers, to have a "massive impact" on Cash App's performance over time.

The stock is still down by more than 75% from its 2021 peak, reflecting slower growth and intensifying competition in fintech. Block still has to keep innovating, but the earnings jump tied to AI productivity could be a real game changer.

At $79 per share, Block trades at about 20 times forward earnings, while analysts expect roughly 25% annualized earnings growth in the next several years. This could be a sleeper growth stock worth buying.

John Ballard has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Block. The Motley Fool has a disclosure policy.