This magnificent Fintech stock is surprisingly climbing aboard the generative AI train
The latest earnings season has only just begun, but the mention of artificial intelligence (AI) on conference calls is more than twice as large as last year, according to Bloomberg. That’s why AI is the hot topic in 2023. And fintech companies Block (SQ -2.58%) has officially entered the conversation.
To be clear, almost every tech company has been using some form of AI or machine learning for years now, including Block. That said, I was a little surprised to see Block jump on board generative AI trains because it’s hard to imagine how such a thing could be used. But as it turns out, it’s a matter of use. The question is, however, whether there is something that can benefit the shareholders.
How Block can use AI
While AI is often used to find patterns in large datasets, generative AI takes the patterns and creates digital content automatically. In its letter to shareholders, Block’s management mentioned two generative AI features specific to the Square ecosystem, the merchant business segment.
First, Block’s management launched a feature that suggests actions a salesperson should take based on what the customer says in a message. This may include sending a bill or sending a voucher. Second, Block’s generative AI allows sellers to automatically create descriptions for their items.
Do sellers want features like these? Apparently so. According to Block’s management, merchants have performed the AI’s suggested action more than one million times since the feature launched in March. Also, sellers have used item descriptions from the generative AI without editing about 75% of the time.
Will AI help block stocks?
Block’s Square ecosystem is extremely important to the business, accounting for 43% of its total gross profit in the first quarter of 2023. However, the growth of the Square ecosystem is increasingly challenged. After posting gross profit growth of 54% and 30% in 2021 and 2022, respectively, Square’s gross profit was up just 16% in Q1 compared to the prior year.
So will AI help revive growth into the Block’s Square ecosystem? It’s tempting to think of it that way. But that doesn’t seem to be how management thinks about it. Speaking about the trends that are changing the world, management wrote: “We want to be proactive in our approach, and not just react when it’s too late.”
To me, this sounds like Block’s management is saying that generative artificial intelligence could become table stakes for fintech companies in the future. Therefore, AI is not so much a way to win the game, but rather to stay in the game.
How should shareholders think about this?
I don’t think Block’s new generative AI capabilities will lead to explosive growth. But I also don’t think Block needs explosive growth to generate strong shareholder returns. At the time of writing, the stock has been completely flat for the past five years, although the business has grown at a fantastic pace.
SQ data by YCharts. TTM = subsequent 12 months.
The growth has been fantastic for Block. And even with challenged growth in the Square ecosystem, the Cash App ecosystem still provides a lot of upside for the business. If Block can be faulted for anything over the past five years, it’s in the area of cash flow — expenses have gotten out of control in recent quarters, which explains why the stock is underperforming the market right now.
The good news for shareholders is that Block’s management has recognized this shortcoming and prioritized rectifying it from here on out. While management’s framework can be a bit difficult to explain without diving into some accounting jargon, I think the gist of the framework can be explained like this: Block is focused on growth while taking “ongoing costs into the business.”
I don’t think AI should be the central tenet if you’re trying to build an investment thesis (an explanation of why the stock will go up) for Block. But AI can keep Block in the game as the industry evolves. And if Block can stay in the game, it has a chance to continue on its growth trajectory. Also, with a renewed focus on keeping costs under control, profit growth could bounce back.
With shares trading at one of the cheapest valuations since it went public in 2015, many investors have written off Block. But I think the risk-reward balance is in investors’ favor today, making it a stock worth considering for your portfolio.
