Square Stock’s Two Growth Drivers Will Still Propel Profits

Stocks to buy

Square (NYSE:SQ) lost plenty of buying momentum on the stock market since late summer. After posting its third-quarter results on Aug. 1, bulls pulled out of Square stock when the company issued a light third-quarter outlook. With EPS guidance below analyst consensus estimates, SQ stock may underperform other electronic payment firms.

Square Stock Has Way Too Much Exposure Because of Its Loan Business

Source: Jonathan Weiss / Shutterstock.com

Square stock plunged from over $80 to below $65 in August when the company forecast Q3 adjusted EPS of 18 to 20 cents. Adjusted revenue of $590 million to $600 million is within the $599 million consensus estimates. Its agreement to sell Caviar to DoorDash for $410 million in cash and DoorDash preferred stock is a positive development.

By getting out of the delivery platform, Square may use the proceeds to invest back in its business. The sale also frees up management from distraction and gives the company higher operating capital flexibility to invest in its two ecosystems.

Two Growth Catalysts for SQ Stock

Square needs to grow the seller ecosystem and the Cash App ecosystem. At 10 years old, the seller ecosystem caters to small and medium businesses. Though it outperformed its expectations, expect monetization of Cash App accelerating. This began with almost no monetization in the past three years to over $500 million run rate in monetization.

SQ attributes this growth to product iteration. The unit now has sustainable growth with strong unit economics. Looking ahead, Square will build out a suite of products and services for both the seller and cash ecosystems.

As a general benchmark, every dollar SQ invests today in growing the seller business from sales and marketing will yield $3 to $4 in three years. But Square stock does not fully reflect that strong ROI ahead. The stock is still sharply below its 52-week high.

Square Stock Headwinds

Square’s focus on sales and marketing efforts for top-of-funnel awareness and activations will hurt short-term results. But as it reaches more sellers, GPV (gross payment volume) will grow. Mid-market sellers are the largest sellers that Square services and it grew at the fastest rate of 45% year-over-year. Looking ahead, its multiple levers of growth on GPV will spread across the rest of its business.

Square has newer payment channels, such as its vertical point-of-sale offerings in retail and restaurants. Its developer platform in omnichannel products will also lift GPV growth.

Competition from other cloud POS (point of sale) players is heating up, but Square has a cohesive ecosystem. Add an array of tools in the offering and more sellers who use them will sign on with Square instead.

Valuation and Your Takeaway on SQ

Investors may assign a terminal revenue multiple of 4.9 times in a 5-year DCF Revenue Exit model. At a discount rate of 12% and an annual revenue growth rate of at least 15%, SQ stock has a fair value of over $75 (per finbox.io).

Square invested heavily in itself to develop its product offering over the last decade. In the next few quarters, it will continue doing so. But its marketing campaign, which started in April, has to happen first. As its brand awareness strengthens, prospective customers will understand its offerings. After they visit SQ’s website, they may choose to activate an account. And having converted and signed up vendors to become sellers to process payments, Square’s GPV will increase.

Square’s market capitalization is small compared to PayPal (NASDAQ:PYPL), Visa (NYSE:V), or Mastercard (NYSE:MA). Assuming that Square’s market reach stays small is a mistake. Investors should consider accumulating SQ stock after its recent dip. If its revenue growth resumes, its stock will move higher.

As of this writing, the author did not hold a position in any of the aforementioned securities.

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