Block’s (NYSE:SQ) Valuation is Starting to Look Attractive - but Volatility Likely to Continue

Shares of Block, Inc . ( NYSE:SQ ), formerly Square, have remained under pressure despite the fact that Jack Dorsey is now devoting more time to the company. On November 28th Dorsey announced that he was leaving Twitter, and a few days later it was announced that Square was changing its name to Block, Inc. Since then the share price has fallen 25%, and it is now down 43% since the August high.

In November we noted the lofty valuation . Now, with the price significantly lower we decided to take a closer look at the valuation. Back then the stock was trading on a very rich price multiple of 182.8x which implied the market was expecting a lot of growth from the company. The P/E ratio is now 136x, which is still very high, but may be justified if expectations remain high.

To see how the current valuation stacks up against the cash flows analysts are expecting, we will run through a Discounted Cash Flow (DCF) model. We would caution that there are many ways of valuing a company and, like the DCF, each technique has advantages and disadvantages in certain scenarios. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model .

View our latest analysis for Block

The calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. 

To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we need to discount the sum of these future cash flows to arrive at a present value estimate:

10-year free cash flow (FCF) forecast

	2022	2023	2024	2025	2026	2027	2028	2029	2030	2031
Levered FCF ($, Millions)	US$952.0m	US$1.45b	US$2.12b	US$3.62b	US$4.72b	US$5.76b	US$6.67b	US$7.45b	US$8.11b	US$8.66b
Growth Rate Estimate Source	Analyst x11	Analyst x11	Analyst x3	Analyst x2	Est @ 30.42%	Est @ 21.88%	Est @ 15.91%	Est @ 11.72%	Est @ 8.79%	Est @ 6.74%
Present Value ($, Millions) Discounted @ 6.7%	US$892	US$1.3k	US$1.7k	US$2.8k	US$3.4k	US$3.9k	US$4.2k	US$4.4k	US$4.5k	US$4.5k

("Est" = FCF growth rate estimated by Simply Wall St)

Present Value of 10-year Cash Flow (PVCF) = US$32b

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.7%.

Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$8.7b× (1 + 2.0%) ÷ (6.7%– 2.0%) = US$187b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$187b÷ ( 1 + 6.7%)10= US$98b

The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$130b. To get the intrinsic value per share, we divide this by the total number of shares outstanding. Compared to the current share price of US$158, the company appears quite good value at a 44% discount to where the stock price trades currently. Remember though, that this is just an approximate valuation, and like any complex formula - garbage in, garbage out.

Looking Ahead:

The most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. Ultimately, what really matters going forward is how the company performs and how expectations change.

Over the last year earnings estimates have trended slightly higher, but it’s important to note that the biggest increases are for the 2025 and 2026 financial years. We are cautious about reading too much into forecasts that far into the future.

Block offers an exciting and growing portfolio of services to consumers and sellers, and is arguably better positioned to disrupt the banking sector than any other company. The name change also proves the company is taking blockchain technology and cryptocurrencies seriously. The unknown factor is how long it will take for all these initiatives to turn into profits. 

The estimated fair value of $281 implies a 44% discount, so the valuation may not be as rich as the P/E ratio suggests. However, the discrepancy probably means we can expect more volatility in the future, as high P/E stocks are extremely sensitive to changing expectations.

If you would like to learn more about Block, as well as 3 other risks we have identified , have a look at our comprehensive analysis of the company.

PS. The Simply Wall St app conducts a discounted cash flow valuation for every stock on the NYSE every day. If you want to find the calculation for other stocks just search here .

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Simply Wall St analyst Richard Bowman and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.