- I analyzed Square eight months ago and found it to be an amazing company with very little margin of safety.
- Since then, the S&P 500 was up 10%, and the stock was down 2%.
- During the same time, the company has outperformed and is now even more attractive.
In February I analyzed Square (NYSE:SQ) after it has announced its quarterly results, and I found it to be an amazing company. I explained what I believe can be Square's most prominent growth opportunities and explained the risks as well. The most dominant risk in my opinion was the lack of margin of safety as the company was trading for a very high valuation.
I believed that for the long-term Square is a buy and I still believe so. Since I wrote the article, Square's stock is down 2% while the broader market is up 10%. While the lack of margin of safety didn't cause investors to lose significant capital, they still lost better opportunities.
On the other hand, as I am going to show, the company has become an even more attractive long-term investment, and long-term investors should seriously consider initiating a position in Square or adding to their existing position due to the company's flat price and improving fundamentals.
According to Seeking Alpha's company overview, Square provides payment and point-of-sale solutions in the United States and internationally. Additionally, it provides Cash App, which enables to send, spend, and store money, and Weebly which offers customers website hosting and domain name registration solutions.
Back in February when I analyzed the company, it offered investors amazing fundamentals. When looking at Square's fundamentals back then, they showed 600%+ revenue growth and 1,500%+ FCF growth. Both of these figures were extremely compelling to begin with as they showed that Square is growing both its sales and generating money.
Many times, companies in their growth phase are losing money or breakeven at best. This is not the case for Square as the company is still growing extremely fast and achieving impressive profitability already that is growing faster. This is one reason I don't look at Square as a "dream company" because while we can discuss the valuation, there is no doubt that it is already a real company that generates real money.
When I look at the consensus of analysts for 2021 according to Seeking Alpha, the company is expected to more than double its revenues and EPS in 2021, and continue to grow both metrics at double-digit rate with EPS growing 25% annually in the medium term, and revenues growing 15% annually.
The graphs below show how the 600%+ and 1,500% growth have accelerated lately, as 2021 is going to be Square's best year. The company is achieving its goals, and it has achieved an amazing Q2 with the company beating analysts' estimates for EPS and showed revenue growth of 143% QoQ.
The valuation is an even more compelling argument. Not only that the company has improved its fundamentals and beat the expectations, but the stagnated share price has made Square even more attractive when I look at the valuation. Back in February, I compared Square to three other peers in the payments business: Visa (V), Mastercard (MA), and PayPal (PYPL).
Back in February, Square was trading for 222 times forward earnings and 573 times its free cash flow. The graphs below are from February 2021, and they show how Square was significantly more expensive than its peers, and I explained it due to its much faster growth rate. Square's peers have executed well, but not as well as Square did in the last 7 months.
However, since I wrote that article, the share price didn't move. Therefore, right now Square has become much more attractive for investors. PayPal and Mastercard are trading for roughly the same valuation. Visa is 20% cheaper than it was, and Square is 44% cheaper than it was just seven months ago when I analyzed it.
Based on the free cash flow it's even more staggering, as Square's price to FCF has declined from 573 to 186 as the company's cash generation improved significantly. PayPal's valuation based on this metric has not changed much, and Mastercard and Visa are somewhat cheaper. Yet none of the pees has seen such a significant decline in its valuation as Square did.
So Square grew fast, and it's growing even faster now. When I compare it to its peers, its valuation is still higher, but it is much cheaper than it was just seven months ago. Using Fastgraphs.com I will compare Square to itself and its historical valuation. The graph below is from February 2021 and it shows how Square is growing faster, and its valuation is higher than its historical valuation.
(Source: Fastgraphs.com, February 2021)
The graph below shows the current valuation of Square. The company is touching its average valuation, and if it is going to keep this valuation, the share price will almost double over the next year. Even under the plausible assumptions that multiples will keep shrinking, Square's amazing growth rate will justify the valuation. When you compare both graphs from Fastgraphs, look at the estimates for 2020, 2021, and 2022.
The company expected 2020's EPS to be $0.75 and it was $0.84, 12% higher than the estimates. In 2021, just seven months ago analysts expected EPS of $1.17 per share, and today they expect $1.87 per share, 60% higher. For 2022 the expectations in February were for EPS of $1.89 and today the expectation is for $2.3, 21% higher.
(Source: Fastgraphs.com, October 2021)
Therefore, Square has grown fast and is growing fast. Analysts forecast fast growth and they keep revising their forecasts upwards because the company is growing at an even faster pace than they expected. Therefore, the company is becoming cheaper when compared to itself and its peers, and investors who loved Square in February should love it even more in October.
The growth opportunities didn't change significantly since February, yet the company has launched new products that are worth discussing as it may serve as a growth platform for Square. The company announced Square banking that will connect with the company's sellers platform. It will offer additional services to clients and will fill the need for another chain in the value chain as business owners and sellers need bank accounts to deposit their proceeds
This new suite of products will help business owners better manage their cash flow and get more out of their money. Square Banking now includes three core products, two deposit accounts, Square savings, and Square checking, joining Square's existing lending products now called Square Loans.Jack Dorsey, CEO, Q2 earning call
Moreover, the company has acquired the Australian fintech company Afterpay which allows clients to buy now and pay later. The company will be an additional service for Cash App clients that will be able to use their digital wallet to buy now and pay later. In addition, the Afterpay module will also be incorporated into the sellers' platform so sellers will be able to use it to increase sales.
I believe that the most significant prospect is the fact that Afterpay will connect both platforms. Before Afterpay Square had two successful products - one for individuals and one for sellers and businesses, now the ecosystem is being merged using Afterpay. A client will use Cash App and Afterpay to buy and pay later, and the seller will have another payment method for clients, and as the use in both platforms is growing so will the impact of combining them.
Next, we're excited by our compelling cross-sell opportunities. By integrating Afterpay directly into our Cash App and Seller ecosystem, we can expand each brand's customer base, strengthen each other's products and build connections. On the consumer side, the addition of Afterpay embeds commerce more directly into Cash App. Afterpay's merchant base will have access to 4x more consumers and Cash App will have access to 16 million Afterpay consumers who represent a complementary demographic base. On the merchant side, we'll introduce Square Sellers to Afterpay's Buy Now Pay Later offering, which expands Afterpay more deeply in the new verticals and in-person commerce.Amrita Ahuja, CFO, Q2 earnings call
The main risks for Square haven't changed significantly in the past seven months. They are competitive risks and regulatory risks. In the regulatory field, there are two main issues, first regulations on financial institutions. As Square is growing it holds more and more capital and the company is not being regulated as banks for example are regulated.
Moreover, there is the possibility of regulation on cryptocurrency. Secretary Yellen stated in January that they may consider regulating crypto. Since then we have seen the Chinese government fighting Bitcoin and in September we have seen that the SEC may start increasing its regulation on this asset class with the support of the Biden administration.
In the competitive area, the company is competing with highly capable peers in every business segment. Cash App is competing for example with PayPal's Venmo, and with Fiserv's (FISV) Clover in the seller's business. These are just two examples, and as the fintech segment is growing, more companies may consider competing on these highly lucrative businesses.
The margin of safety is another risk. I believe that the company's valuation is justified due to its superb growth rate. However, if the company cannot maintain the expected growth rate, its valuation will become expensive. The company's execution is necessary to achieve justification to the valuation and every significant slowdown will have an impact.
Square is probably one of the most promising companies in the market right now. The company is growing fast and is poised to keep growing fast. Moreover, due to its share price stagnating over the last seven months its valuation has improved while the fundamentals have improved.
The value proposition that Square offers is highly attractive both to its clients and to its shareholders. Therefore, in my opinion, investors who wish to have additional exposure to the financial services sector should buy shares in Square as the company offers fast growth, and what I believe to be limited risks.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of V, SQ either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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