3 Reasons Growth Investors Should Still Consider Square Stock

On its face, Square (NYSE:SQ) stock looks like anything but a buy. Looking even to 2021 earnings, Square stock looks prohibitively expensive. And few stocks, even in this torrid market, have posted bigger rallies off March lows.

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Indeed, SQ has rallied an incredible 603% off its March lows. Its market capitalization now is over $100 billion; ten months ago, it was at $15 billion.

A big part of the gains have come from investors applying an ever-higher multiple on the company’s profits. Even in 2019, before the novel coronavirus pandemic hit 2020 (and likely 2021) results, SQ generally traded in the range of 50x or 60x forward earnings. Based on consensus estimates for 2021, that figure now is 200x.

It’s certainly possible that the rally has gone too far. Valuation indeed looks like the biggest risk. But investors across the market have been rewarded for paying up for growth. For several reasons, those investors still willing to follow that strategy should keep Square stock on their watchlists.

The Pandemic, Investment and Valuation

Square’s enormous forward price-to-earnings multiple can’t be explained away just by the pandemic. But the pandemic is a factor in that multiple.

After all, 2021 revenue and earnings are going to be depressed. Square has a significant number of customers that are small businesses and/or restaurants. Many of those businesses remain closed, and no doubt will see decreased traffic even once some semblance of normalcy returns.

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Lower traffic means lower sales for the business — and lower revenue for Square. And the nature of a platform business means that modestly lower revenues can lead to sharply lower profits. (Of course, the reverse is also true, a key reason why investors are willing to pay a premium for the likes of Square.)

It’s not just the pandemic that will reduce 2021 profits. Square is investing behind its business. It’s almost certainly not charging the exact highest rates it could. Research and development and marketing spend all are elevated, as the company looks to spend in the short-term to attract customers that will be hugely valuable over the long haul.

Of course, that spend isn’t going to just to the legacy business. Initiatives like Cash App and Square’s bitcoin business both require upfront investment. Over time, as those businesses both grow, Square will benefit both from higher revenue and higher margins — an attractive one-two punch.

Cash App

To be honest, I personally am not terribly bullish on Square’s legacy point-of-sale business. The market is intensely competitive, and it’s not as if Square is a clear leader.

It’s worth noting that Square processed $31.7 billion in Seller GPV (gross payment volume, or the amount of merchant sales run through the platform) in the third quarter. Clover, part of payment processor Fiserv (NASDAQ:FISV), did $33 billion at a higher growth rate (30% for Clover versus 12% for Square). Fiserv is worth roughly 75% as much as Square, and FISV stock trades at just 20x forward earnings.

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But Square has two big initiatives that have real potential, and can attract still more growth investors. The first is Cash App. The business has posted absolutely torrid growth, and seems to so far have outcompeted Venmo from rival PayPal (NASDAQ:PYPL).

The move into business-to-business has been a huge success, with business GPV up 332% year-over-year in Q3. Cash App as a whole more than tripled gross profit on the back of 154% growth in subscription and services-based revenue.

Cash App is a hugely valuable business, but one that likely is a minimal contributor to overall profit at this point. But with nearly $1 billion in gross profit over the past four quarters, an optimist could argue that Cash App alone supports a reasonable chunk of the current $105 billion market capitalization.

In this market, a software company generating $1.5 billion in revenue at 70% gross profit might well have a market valuation above $25 billion. An investor reasonably could argue that Cash App, were it a standalone business, deserves to be at least in that ballpark.

Bitcoin and Square Stock

And, of course, there’s bitcoin.

Now, it’s possible that the continued rally in Square stock is coming from investors buying the stock solely as a bitcoin play. For bitcoin skeptics like myself, that might be a red flag.

That said, Square stock hasn’t exactly gone nuts. Over the past three months, it’s gained 21%. Bitcoin has rallied over 160%. MicroStrategy (NASDAQ:MSTR) has soared 236%, and Riot Blockchain (NASDAQ:RIOT) has gained an incredible 575%.

So, at least in the past few months, SQ hasn’t exactly been part of the bitcoin bubble (assuming it is a bubble, an assumption with which bulls obviously would disagree). And there is real potential value in the company’s bitcoin efforts, even beyond its current holdings of the cryptocurrency.

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Indeed, Square generated $32 million in gross profit from bitcoin in Q3. That figure rose 11x year-over-year. As with Cash App, this is a business that as a standalone would have real value.

To be fair, there is a question as to whether there’s enough value in bitcoin and Cash App to justify a market capitalization over $100 billion. And if this market turns south, SQ stock is going to take a big hit.

But that’s been true for a while now, and particularly true over the past year. Yet Square stock is up 232%. Investors betting that the optimism toward growth stocks will hold might not want to get off this ride just yet.

On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

View more information: https://investorplace.com/2021/01/3-reasons-growth-investors-consider-square-stock/

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