For the most part, growth stocks have had a really good 2019 as stabilizing global economic conditions have converged on plunging rates to create an ideal investment backdrop for long duration assets. The iShares S&P 500 Growth ETF (NYSEARCA:IVW) is up more than 20% year-to-date. But one growth stock that has come up short in the big 2019 rally is Square (NYSE:SQ) stock.
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In 2019, SQ has struggled with competition concerns and slowing growth trends against the backdrop of a rich valuation — a combination which has ultimately resulted in SQ stock rising only 12% year-to-date and being down 30% over the past year.
Will the struggles in SQ stock continue? I don’t think so. At $60, the long-term bull thesis on Square stock looks incredibly compelling from a fundamental valuation perspective. At the same time, the optics surrounding Square stock should improve over the next few months, and that improvement should inject confidence back into the investor base.
Net net, I think the fundamentals and optics underlying SQ stock lay the groundwork for a compelling reason to buy the stock at $60. Will it run higher immediately? Probably not. But does it have immense upside potential from here in a multi-quarter to multi-year window? Absolutely.
As such, for investors who are willing to be patient, SQ stock looks like a great buy here.
The Fundamentals Are Very Attractive
The story on Square is pretty easy to understand. Everywhere, all across the globe, consumers are pivoting from cash to non-cash payment methods, such as card and digital payments. In order to keep up with this secular pivot, merchants, retailers, and restaurants everywhere need to adopt payment processors which handle all types of payments. Square sells these payment processors.
So do a lot of other companies. But Square is differentiated in three big ways. First, they’ve built a software ecosystem surrounding their payment processors which helps merchants of all sizes modernize, digitize, and automate workflows. Second, they’ve built this ecosystem to be particularly advantageous for small-to-medium sized businesses who are often behind the curve on modernization and digitization. Third, their payment processors come in all shapes and sizes — ranging from a mag-stripe smartphone attachment, to a full-on register — so that merchants can sell whenever, wherever, and however they want.
Thus, the core growth narrative here is that as cash increasingly becomes obsolete and card payment volume continues to grow, Square will leverage its unique advantages to grow relevance, reach, and share across the global retail world. That was a $24 trillion world back in 2018, of which Square only controlled about 0.35%. In the long run, then, Square has a tremendous opportunity to sustain 20%-plus revenue growth for a lot longer, which should drive healthy margin expansion through positive operating leverage.
Zooming out, Square projects as a 20%-plus revenue grower into 2025, with sizable upside margin drivers. Net net, that paves a tangible pathway for EPS to $4 by 2025. Based on a payment processing average 30-times forward multiple and a 10% discount rate, that equates to a 2019 price target for SQ stock of $75.
The Optics Will Improve
To be sure, the fundamentals have pointed to a 2019 price target for SQ stock of $75 for some time now. Yet, Square stock has languished around $60 for over a month.
Clearly, Square stock needs a catalyst outside of “it’s undervalued” to shoot shares higher.
That catalyst could come over the next few quarters as the optics surrounding the stock materially improve. This breaks down into three parts. First, I expect the broader financial market backdrop to improve over the next few months as trade tensions ease (neither side wants the trade war to escalate further), U.S. consumers spend big during the holiday season (everyone is working and making more), and rates remain low (inflation is muted everywhere).
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Second, SQ stock is showing resilience at a multi-year support line narrowly above $60. The lower $60’s have proven to be a “bottoming” area for Square stock twice before since mid-2018, breaking only once during the late 2018 stock market wipe-out. If Square stock does indeed hold this lower $60’s level again, then technical traders will rush into the stock, and that will provide an upward lift for the stock.
Third, I think the numbers will get better from here. Square’s revenue growth has been decelerating recently, but it should stabilize over the new few quarters as new investments start to yield healthy returns. These investments include the roll-out of Orders API to help merchants manage order fulfillment, the build-out of the Cash App ecosystem, the launch of Square Terminal in Australia, operational expansion among bigger merchants, and more.
Bottom Line on SQ Stock
It’s been a rough ride in SQ stock over the past year, But this turbulence is to be expected after SQ stock rallied about 700% from mid-2016 to mid-2018.
In other words, in the big picture, the past 52 weeks of weakness in Square stock is a just a blip on the radar — a minor consolidation period in a long-term uptrend. Importantly, the growth fundamentals here remain highly favorable, and because of such, SQ stock can and will move significantly higher in the long run.
As of this writing, Luke Lango was long SQ.
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