Square (NYSE:SQ) stock tanked in early May after the payments processor’s first-quarter results beat analysts’ expectations, but it delivered downbeat Q2 guidance. In the wake of the lackluster guidance, the Street’s growth and competition concerns about SQ were reinvigorated. As a result, SQ stock dropped nearly 10%, falling to its lowest levels since January 2019.
This selloff of SQ stock is overdone. Square is at the epicenter of a non-cyclical shift in the global economy from cash to cash-less payments. Within that shift, Square’s presence and share are growing across multiple channels, including both the brick-and-mortar and e-commerce fronts. After comparing the company’s current market share to its long term total available market, I think SQ has tremendous growth potential over the next several years.
Plus, the company has a created a suite of subscription and service businesses which should provide healthy growth catalysts over the next several years. Square is also digging into banking, a potential new growth market which could eventually be quite lucrative. On top of all that, SQ’s profit margins are steadily rising.
In other words, Square still is and will continue to grow rapidly, while SQ has tremendous long term potential.
With SQ stock sitting below $70, that potential is being undervalued . As a result, the recent selloff of Square stock appears to provide investors with a chance to buy the shares of a winning company on weakness.
The Bears on Square Stock Underestimate SQ’s Opportunity
According to those who are bearish on SQ stock, SQ has built a payments processing empire in the micro-merchant world. But that world is becoming saturated, and in order to continue to generate rapid growth, SQ is expanding by creating solutions for larger sellers. According to the bears, the problem is that these bigger sellers already have a suite of payment processing solutions, ranging from First Data (NYSE:FDC) to PayPal (NASDAQ:PYPL) to Shopify (NYSE:SHOP) to big banks.
Thus, as SQ gets bigger, it’s starting to rub elbows more frequently with the competition, and Square is having trouble with all this competition., the detractors of SQ stock say. That’s why the company’s growth is slowing and this slowdown will persist, causing the richly valued SQ stock to drop, they conclude.
That thesis sounds pretty valid. When the company behind a hyper-growth, richly valued growth stock slows down, its shares usually fall. But the bears underestimate just how big the company’s opportunity is, and how much room Square has to grow, despite its big competitors.
SQ Stock Will Win Over the Long-Term
The value of global retail sales was about $24 trillion last year. Square’s gross payment volume in 2018 was about $85 billion. Thus, SQ processed just 0.35% of all global retail sales last year.
But that’s up from 0.23% in 2016, and 0.29% in 2017. Thus, SQ is a small company whose share of the global retail market is rapidly increasing.
That trend should persist. Square’s non-cyclical tailwinds remain healthy, and consumers continue to use cash-less payments more frequently. Moreover, Square is finally making a big push into e-commerce with its Square Online Store. The company is also rapidly gaining share among large retailers. Further, the company has not yet tried very hard to penetrate the overseas and banking markets.
Square’s potent strategies should enable its market share to continue to grow, causing its revenue to rise quickly. Meanwhile, its margins are consistently trending higher, so its profit growth is and should remain robust.
Given all of Square’s positive catalysts, SQ stock should be bought on all major dips, as long as its valuation isn’t excessive.
The Valuation of SQ Stock Is Attractive
At its current levels, the valuation of SQ stock is highly attractive for long-term investors.
On a trailing price-sales basis, SQ stock is as cheap as it gets in the payments processing world. SQ’s trailing sales multiple stands at eight, versus an 8.3 sales multiple for PayPal, and mid-teens sales multiples for Visa (NYSE:V) and Mastercard (NYSE:MA). Also, the valuation of SQ stock bottomed at roughly eight times sales in late 2018, so Square stock is trading just above a meaningful resistance level.
Over the long-term, Square’s annualized revenue growth should stay at roughly 25% over the next several years, assuming the company continues to gradually grow its share of the global retail marketplace. Adjusted EBITDA margins should ramp from the 18% expected this year towards an eventual peak of 30%.
By 2025, I think Square’s earnings per share can reach $4.50. All the other payment stocks trade at 30-plus forward price–earnings multiples. Based on a 30 forward multiple, a reasonable 2024 price target for Square stock is $135. Discounted back by 10% per year, that equates to a 2019 price target of over $80.
The Bottom Line on SQ Stock
SQ stock has declined tremendously because of fears that its growth is slowing. But such fears are short-sighted, since its growth is only slowing gradually, and it still has enough long-term potential to support strong growth for the foreseeable future. Meanwhile, investors seem to be ignoring the fact that SQ’s margins have been consistently trending upward.
Ultimately, this combination of persistently high revenue growth and margin expansion will power SQ stock significantly higher from today’s depressed levels.
As of this writing, Luke Lango was long SQ, PYPL, and SHOP.
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