We recently published a list of The 16 Most Undervalued Stocks You Should Buy Now. In this article, we take a look at how Block, Inc. (NYSE:SQ) compares to other undervalued stocks.
With the U.S. stock market hitting record highs, largely due to significant contributions from major technology sectors, domestic and global investors continue to monitor market dynamics to capitalize on potential opportunities. Therefore, it is important to identify undervalued stocks as they can offer significant value given the high valuations across all sectors.
Concentration of the S&P 500
Thanks to the “Magnificent 7” stocks that caught investors’ attention in 2024, the market capitalization concentration of leading U.S. stocks is the highest in decades. Strategists at Goldman Sachs estimate that the 10 largest U.S. stocks now account for about 33% of the market value of the S&P 500 index, well above the share of about 27% reached at the peak of the tech bubble in 2000.
The current concentration contributed to a period of strong returns in the U.S. market. The market has delivered an annualized total return of ~16% over the past five years. This compares to the 30-year annual average of 10%. According to Goldman Sachs, the top 10 stocks accounted for over a third of this gain. However, “today’s top stocks trade at lower valuations than the largest stocks at the height of the tech bubble in 2000.”
Despite good returns, investors are concerned about the extremely high level of market concentration compared to the recent past.
There are apparent similarities between current conditions and the 1973 and 2000 episodes. The labor market appears to be in decent shape, and concentration has increased along with robust stock market returns. In those episodes, the peak of stock market concentration also led to the peak of a bull market, and the U.S. economy faced recession fears in the following year.
However, the experience of 1964 shows that a sustained bull market can continue to rise despite declining market concentration. After market concentration peaked, stock prices and the U.S. economy remained stable for a long time.
Are US stocks overvalued or undervalued?
Valuations of the largest stocks are well below previous peaks. Currently, the top 10 stocks continue to trade at a collective P/E of ~25x, well below the top valuations of the largest stocks in 2000, 2020, and mid-2023.
Valuations are also lower when you consider the premium at which the largest stocks trade compared to the rest of the market. That said, the ~35% valuation premium today is still well below the 80% premium seen in mid-2023 and the 100% premium in 2000. Although the degree of market cap concentration is actually higher today than at the 2000 peak, the largest stocks trade at much lower multiples than they were during the tech bubble.
Our methodology
We used the Finviz screener to create the list of 16 most undervalued stocks to buy now. We created a shortlist of stocks that are expected to report earnings growth this year and have a P/E ratio of less than ~21.66x (since the market is trading at a P/E ratio of ~21.66x). We ranked the stocks in ascending order of their hedge fund sentiment.
Why do we care about the stocks hedge funds invest in? The reason is simple: Our research has shown that we can outperform the market by mimicking the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks each quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points. (Further details can be found here).
People using Cash App to pay for goods and services illustrate the impact of the company’s payment tools.
Block, Inc. (NYSE: SQ)
Forward P/E as of August 22: 18.94x
Number of hedge fund owners: 59
Expected EPS growth this year: 100%
Block, Inc. (NYSE:SQ) provides merchant payment and related services. The company also launched Cash App, a person-to-person payment network.
Block, Inc. (NYSE:SQ) is targeting growth. The company’s “Rule of 40” plan through 2026 sets the bar high, with gross profit and adjusted operating income targets set at ~15% and ~25%, respectively (the sum equals 40%). The company’s adjusted EBITDA margin increased from 17% in 2020 to 24% in 2023.
Block, Inc. (NYSE:SQ) expects that number to increase to 33% this year, with the company focusing on cutting costs rather than increasing revenue. Management expects a combined total market (based on gross profit) of $190 billion for Square and Cash App. The company will apply its signature gaming concept to attract customers and increase usage by introducing new product features and expanding into new markets.
Block, Inc. (NYSE:SQ) is likely to benefit from switching costs. Merchants who rely on Square’s mission-critical partners are somewhat locked into the ecosystem. Additionally, consumers who conduct their basic banking through Cash App have no desire to switch providers. Aside from switching costs, the company’s network effects are also likely to drive growth. Its ecosystem offers features for every business, from point-of-sale to financial assistance.
Analysts at Citigroup increased their price target on shares of Block, Inc. (NYSE:SQ) from $86.00 to $90.00. They issued a rating on the stock on March 6.th May. In the second quarter of 2024, there were 59 hedge fund holders in the company.
Baron Funds, an investment company, has released its investor letter for the second quarter of 2024. Here is what the fund said:
“Block, Inc. (NYSE:SQ) provides point-of-sale technology for small businesses and operates the Cash App ecosystem of personal financial services. Shares gave back gains from earlier in the year despite reporting strong quarterly results and raising full-year guidance. In the first quarter, gross profit rose 22% and EBITDA rose 91%, both beating Wall 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 gross profit growth of at least mid-teens and mid-20% operating margin. We continue to hold the stock due to Block’s long growth perspective, durable competitive advantages, and innovative product offering.”
Total SQ takes 8th place on our list of the most undervalued stocks to buy. While we recognize SQ’s potential as an investment, we believe some highly undervalued AI stocks promise higher returns and do so in a shorter time frame. If you’re looking for a highly undervalued AI stock that shows more promise than SQ but trades at less than 5x earnings, read our report on the cheapest AI stock.
READ MORE: $30 trillion opportunity: The 15 best humanoid robot stocks to buy, according to Morgan Stanley And According to Jim Cramer, NVIDIA has “become a wasteland”.
Disclosure: None. This article was originally published on Insider Monkey.
