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4 Reasons I Bought Square, Inc. Stock
Daniel Sparks, The Motley Fool
Updated
Even after missing out on financial technology company Square's (NYSE: SQ) enormous 150% run-up in its stock price during 2017 (and a 242% rise since its IPO in 2015), I still decided to pick up some shares. Here are four reasons I recently bought Square stock.
1. Accelerating growth
Square's 45% year-over-year growth in adjusted revenue, or net revenue less transaction-based revenue from Starbucks and transaction-based costs, during its most recent quarter is impressive in its own right. But what's particularly notable is how Square's strong revenue growth rates are accelerating recently. This 45% growth was up meaningfully from the 41% year-over-year rise in its second-quarter adjusted revenue. Furthermore, second-quarter adjusted revenue growth was above first-quarter growth of 39%.
A customer using a chip reader built into Square Register to pay for something
Similar trends can be seen in growth in total net revenue during these periods, with total net revenue rising 33% year over year in the third quarter of 2017, compared to 26% and 22% growth in the second and first quarters of 2017, respectively.
Metric
Q3 2017
Q2 2017
Q1 2017
Total net revenue year-over-year growth
33%
26%
22%
Adjusted revenue year-over-year growth
45%
41%
39%
Data source: Square quarterly shareholder letters. Table by author.
2. Product expansion
Nomura Instinet analyst Dan Dolev, who has a $64 price target on Square stock, recently argued that one of Square's opportunities is the ongoing expansion of its services as it grows and continues to attract more large sellers.
"In 10 years, Square is likely to be a very different company helped by accelerating share gains from payment peers and relentless disruption of services like payroll and [human resources]," Dolev wrote in a note to clients in January. Specific examples of Square's opportunity for expansion are "growing penetration of higher priced transaction types like virtual terminal and e-commerce, as well as high margin services like Square Capital and payroll," Dolev said.
Having quickly evolved from a mobile payments company to a full-out financial technology company while simultaneously moving upstream from small to midsize and even large businesses, Square has demonstrated prowess in its ability to expand and scale -- and this will likely continue.
Consider the recent launch of Square's Virtual Terminal in October 2016. Taking just two months to build using its E-Commerce API, Virtual Terminal allows sellers to take payments in a web browser. "This shift in product context away from a mobile device is subtle on the surface," Square explained in its most recent shareholder letter, "but significant for sellers that run their businesses on a computer where companion tools such as email, customer lists, and scheduling operate alongside Virtual Terminal." The new product opened the door to a new wave of customers and a significant market opportunity. About half of Virtual Terminal's gross payment volume comes from sellers that are new to Square's ecosystem and Virtual Terminal is Square's fastest-growing product, already reaching $1 billion in cumulative gross payment volume, with $350 million processed in the third quarter alone.
3. Partner integration
One of the ways Square is expanding its business is by making it easier for its ecosystem to integrate with partners. To this end, it launched Build with Square, or a set of APIs (application programming interface) for sellers to create custom integrations between Square products, services, and data with other business systems.
Twitter CEO Jack Dorsey commented on the continued runway for partnerships in the company's third-quarter earnings call.
We continue to add new software partners. We still believe we're in the early phases of Build with Square. ... The software is certainly not set. We have a bunch of evolution we want to make. We're really focused on the developer experience right now. ... We do believe this is a really critical aspect of our work. We are showing that's working, but we believe there's a ton more potential that we're excited about.
4. Lucrative subscription and services
Though Square's subscription and services segment accounts for just 11% of total revenue, there's good reason for investors to give it significant weight in their analysis. Subscription and services-based revenue is soaring, rising 84% year over year in the company's most recent quarter. In addition, the segment is highly lucrative. Even though it accounts for 11% of revenue, it represents 21% of Square's gross profit.
Instant Deposit, Caviar, and Square Capital have been key drivers for the segment, Square said. But management highlighted notable momentum in Instant deposit and Square Capital in its third-quarter shareholder letter:
Specifically, Instant Deposit volume of $2 billion in the third quarter benefited from increased usage by Square sellers and Cash app individuals, both of whom value speed to access their funds. Square Capital facilitated 47,000 business loans totaling $303 million, up 45% year over year.
The risks
The primary risk to buying Square stock is its overlap with other disruptive fintech companies like Shopify, and PayPal. Though Square is in a fast-growing market, competition similarly wants to capitalize on lucrative opportunities. Shopify and PayPal have been rapidly expanding their product offerings and partnership integration. Eager competition, therefore, could stifle some of Square's upside and possibly even erode customer switching costs as Square partners integrate with other fintech companies.
Shopify e-commerce platform on a smartphone, laptop, and tablet atop a wooden table.
Valuation is also a concern. Square's price-to-sales ratio of 8.1 compares to an average of 6.2 for software application peers. Furthermore, trading at 106 times the consensus analyst estimate for next year's earnings per share, the stock is already priced for more rapid growth in the coming years. If growth decelerates too quickly, shares could prove to be overvalued.
But with strong catalysts leading to accelerating revenue growth recently, momentum certainly seems to be in Square's favor. Sure, a stock like this could trade with significant volatility in the near term, but I believe it will be a winner over the long haul.
Daniel Sparks owns shares of Square. The Motley Fool owns shares of and recommends PayPal Holdings, Shopify, and Starbucks. The Motley Fool owns shares of Square. The Motley Fool has a disclosure policy.
