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Square Stock Is Benefiting From the Strong Economy

Dana Blankenhorn

Square (NASDAQ:SQ) stock has performed extremely well in this market. SQ stock has soared more than 150% just since the start of 2018, and now has a market capitalization of $41 billion dwarfing that of many of its rivals in the payment space. SQ stock can continue to rise, as long as the economy keeps expanding rapidly.

The Successful Business Model of SQ

Square’s business model is easy to understand. Square uses its phone-based device and simple pricing for small businesses the way Apple (NASDAQ:AAPL) uses its iPhone. That is, Square uses those enticements as a way to get its foot in the door of the small businesses and then sell them a host of valuable services.

Among these services are payroll processing, a notorious hassle for small businesses. I should know, since I’m an LLC myself, and even with just one employee, I find payroll complex enough to warrant a service to handle it.

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But Square has a bigger fish to fry.

Square Bank

The bigger fish is Square Cash, an app that is letting Square act as both a bank and a marketplace for its clients. Think of Square Cash as a Paypal (NASDAQ:PYPL) for businesses, letting small companies pay suppliers or collect payments from customers. Businesses pay Square a 1.5% fee when they receive payments.

Square Cash lets businesses store their cash with SQ, borrow with Square Capital, and will increasingly let them invest through Square. Through an alliance with eBay (NASDAQ:EBAY), Square is marketing its lending service to thousands of small online merchants.

Investors seem to be enthusiastic about these ideas, as the market capitalization of SQ stock is well above that of a number of its payment rivals like Total System Services (NYSE:TSS).

TSS has a market cap of $18 billion, with sales of $4.9 billion, net income of $584 million, and a growth rate last year of 18%. SQ, meanwhile, had a loss last year of almost $63 million on $2.2 billion in revenue, a growth rate of 29%, and now has a $41 billion market cap. (TSS had $2 billion of revenue in the first half of 2018, while Square’s top line came in at $1.5 billion during the same period.)

Investors, in short, are paying a huge premium for Square’s growth, ignoring the bottom line, bidding the valuation of Square stock far above that of its peers. Meanwhile a “short squeeze” has helped power the price of Square stock higher.

What’s Next for SQ Stock?

Valuation isn’t so important, insist the Square bulls. Analysts are expecting $830 million of revenue when Square next reports its earnings on Halloween, and yet-another loss.  If Square’s results are in-line with the consensus estimates, its losses would be on track to rise 25%-30% this year.

But while SQ stock is now trading at 12 times its expected revenue for 2018, rivals like Total Systems are trading at just four or fives times their revenue, which continues growing, and unlike Square they generate profits.

The Bottom Line on SQ Stock

SQ is a good company, with a good story, and if you have held Square stock for a few years, you’re a happy camper.

But small businesses are, by their nature, an emerging market. Small businesses can do very well in an economic boom, but are just as likely to suffer grievously during an economic bust.

Know that if you own SQ stock, you’re leveraged to good times. You should sell Square stock if there is any sign that the economy is about to retreat. But until then, let the good times roll and stay out of the way until the economy’s day of reckoning.

Dana Blankenhorn is a financial and technology journalist. He is the author of a new mystery thriller, The Reluctant Detective Finds Her Family, available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this article.

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