This digital payments company is forecast to grow by 55% this quarter and 69% next quarter.
In selecting today’s stock, I swung back to the aggressive side, prospecting among Mike Cintolo’s latest recommendations in Cabot Growth Investor. This stock has great upside potential.
Square (SQ)
From Cabot Stock of the Week
Here are Mike’s latest thoughts on the stock. Square (SQ) The digital payment industry is chock-full of competition, but most of that competition seems focused on big business and money transfers among individuals; that’s where firms like MasterCard, Visa and PayPal generally battle. Square, on the other hand, is mostly focused on the needs of small- and mid-sized businesses, a gigantic market that’s driving the firm’s growth.
Square, of course, is best known for its little white dongle (great word) that attaches to a smartphone or tablet, which, along with the firm’s software, effectively turns the device into an electronic cash register, allowing any sort of merchant to easily collect money from any form of credit or debit card. In recent quarters, Square has also introduced chip card readers and even swipeless card readers for services like Apple Pay.
Even though it serves smaller businesses, Square’s system still processes lots of money; in the third quarter alone, the company’s customers processed $13.2 billion of orders, up 39% from the year before. Of that total, 57% came from customers that process less than $125,000 per year, with just 14% processing more than $500,000 annually (though that figure is up from 11% last year).
Basically, as Square’s customers grow, so does Square’s top line; transaction revenue grew 38% in the third quarter, slightly slower than the firm’s overall adjusted revenue growth of 51%. (Note that the company’s “adjusted” revenue strips out transaction costs and a soon-to-be-expired Starbucks deal from the totals; it’s the figure Wall Street focuses on more than reported revenue.) The company takes an average of 2.93% of every transaction; after all costs, the firm ends up with just over 1% of each transaction as profit.
But, while transaction growth (both from getting new clients and from those clients expanding) has a long runway of growth, it’s far from Square’s only growth avenue. The company has made an aggressive push into ancillary services such as instant deposit, cash advances, invoices, marketing help, payroll, analytics and gift cards.
The company has even dipped its toe into the online food ordering industry via its Square Order service and a couple of related acquisitions. Combined, these products saw revenues up a whopping 140% in the third quarter and most analysts believe they’ll be the biggest growth driver going forward, allowing Square to better monetize its customer base. Management believes these services will eventually make up a quarter of all revenues, up from a few percent today.
Square remains in investment mode, and that means losses are still fairly hefty. But even there we see improvement. EBITDA (a measure of cash flow) has been positive each of the past two quarters and should expand going forward. The next quarterly report is due out on February 22.
All told, there’s little question that Square’s story and potential are huge, and Wall Street knows it; the company’s market cap is right around $5 billion, so there are clearly high expectations for continued rapid revenue and EBITDA growth. But the valuation doesn’t scare us, as Square has a unique brand and business, which big investors will often pay up for.
Square’s fourth-quarter earnings report, due out February 22, presents a small short-term risk. But I like the way the stock has pulled back calmly to 14 (right near its 50-day moving average) over the past four weeks, and I think the support provided in this area outweighs the earnings risk.
Timothy Lutts, Cabot Stock of the Week, www.cabotwealth.com, 978-745-5532, February 7, 2017