Hold up — Block Stock Is Not a Buy on the Dip. Here’s Why.

Controversial hedge fund Hindenburg Research just found its latest short target. Hindenburg publishes research on companies that it believes deserve more scrutiny. In its latest piece, the hedge fund identified payments company Block (SQ) as its new target. The day following the report, Block stock fell roughly 15%. Let's dig into Hindenburg's claims and analyze if this is a buy the dip opportunity.

Is Hindenburg Research credible?

Generally speaking, investors should act with an extra level of caution when a company is slapped with a short report. In its most basic terms, shorting a stock means to bet against it. For example, if an investor thought that the price of a particular stock may go down, they could (potentially) profit by purchasing put options

When it comes to Hindenburg, the company seems to have a knack for creating headlines while also, frankly, pointing out the obvious. Per a Bloomberg report published earlier this year, Hindenburg was short Twitter and electronic vehicle company Nikola. Both of these equities were troubled companies. In the case of Nikola, the company has been under fire since its public debut in 2020. As for Twitter, well, that's Elon Musk's problem now.  

So, what is Hindenburg's issue with Block? Well, at the heart of the report is Block's peer-to-peer payments platform called Cash App. Per the Hindenburg website: “Our 2-year investigation has concluded that Block has systematically taken advantage of the demographics it claims to be helping. The ‘magic' behind Block's business has not been disruptive innovation, but rather the company's willingness to facilitate fraud against consumers and the government, avoid regulation, dress up predatory loans and fees as revolutionary technology, and mislead investors with inflated metrics.”

Hindenburg alleges that Cash App is facilitating transactions among organized crime. It goes so far as to say that Block is turning a blind eye and profiting from these fraudulent transactions.

That's quite the litany of accusations. Hindenburg's source? A few (alleged) interviews from insiders, coupled with rap songs. Are you taking this seriously yet?  

What do the fundamentals say?

For a moment, let's isolate the short report and look at Block's entire business.

For the year ended Dec. 31, Block reported total revenue of $17.5 billion. This is a modest decrease from the year prior, during which Block reported $17.7 billion of total revenue. While transaction-based revenue (Cash App) increased 19% year over year to $5.7 billion, revenue from crypto assets like Bitcoin declined by roughly 40% to $7.1 billion.

The decrease in revenue coupled with a bloated expense profile led to some steep losses for Block. The company's total operating expenses increased 53% year over year, with general and administrative and product development costs increasing 73% and 50%, respectively.

Unsurprisingly, Block's operating cash flow decreased significantly, from $848 million in 2021 to $176 million in 2022.

Should investors be concerned?

None of this is to say that Hindenburg lacks credentialed financial analysts. However, when looking at Block's fundamentals versus Hindenburg's rationale for shorting, it doesn't seem like the company is looking at the whole picture. 

In response to Hindenburg, Block stated:

I agree with Block's argument that these types of reports from Hindenburg, and others like The Bear Cave, are often issued to help short-sellers profit from suffering stocks. But pursuing legal action may not be in the best interest of shareholders in the near term.

On one hand, investors should applaud Block's management team for taking swift action and cooperating with the Securities and Exchange Commission. On the other hand, legal endeavors are usually time consuming and expensive. 

The financials above illustrate that Block has enough challenges with its existing business. Revenue is down nominally, while expenses are up materially. Big tech has had no shortage of issues over the last several months as consumer demand wanes and fears of recession rise. Furthermore, Block stock is down 46% over the last 12 months.

For current shareholders, selling out of fear or panic rarely, if ever, is the proper thing to do. Despite the stock price dropping on the news of the short report, the company's financial results and current profile do not exactly make it a screaming buy at the moment. Investors with a long-term mindset may want to sit on the sidelines for the time being and assess future earnings results. 

Originally published on Fool.com