Personal Finance

Forget PayPal -- Square Is a Better Growth Stock

An employee and customer interact with the two displays included with Square Register

The rise of fintech presents a great opportunity for investors looking to land the next multibagger stock. If you had invested $10,000 in PayPal Holdings (NASDAQ: PYPL) stock just three years ago, you would be sitting on an investment worth $26,700. However, a $10,000 investment in Square (NYSE: SQ) stock would be worth a whopping $76,000.

While I doubt Square stock will deliver those same returns over the next three years, I believe it could continue to outperform PayPal stock going forward. For one, Square is chasing a similarly sizable addressable market as PayPal, but Square has the benefit of growing off a smaller base of revenue. More importantly, Square's momentum looks sustainable, as management keeps finding new ways to grow the company.

An employee and customer interact with the two displays included with Square Register

Square Register. Image source: Square.

The numbers don't lie

Square is clearly doing a lot of things right to drive high returns for shareholders. Over the last three years, Square's revenue climbed a total of 161%, faster than PayPal's revenue growth of 74%. In the third quarter of 2018, Square's revenue rose 51% year over year and adjusted revenue increased 68% year over year. Excluding the acquisitions of Zesty and Weebly, adjusted revenue grew 56% year over year, which marked the company's sixth consecutive quarter of accelerating revenue growth.

What's more, robust top-line growth has had a profound impact on Square's profitability. In the last quarter, adjusted EBITDA increased 107% year over year to $71 million.

As evident in those numbers, management sees tremendous momentum heading into 2019. The company is calling for adjusted revenue growth of at least 40% over 2018 and for continued improvement in adjusted EBITDA margin. In contrast, analysts expect PayPal to grow revenue by 18% this year.

Square's momentum is a testament to the strength of its ecosystem of services for small businesses. The company has moved well beyond making credit card readers that plug into a smartphone. Square only generated $50 million in revenue from selling point-of-sale hardware through the first three quarters of 2018. A much bigger slice of revenue is coming from subscriptions and services for things like payroll management, invoicing, and business loans from Square Capital.

Square also has a growing business with its Caviar restaurant ordering service and its Cash app -- a peer-to-peer payment app that is proving to be more popular than PayPal's Venmo app. In recent months, the Cash app has been downloaded more often than Venmo.

Square generates revenue from the Cash app through charging small fees for things like Instant Deposit, as well as offering a debit card (or Cash Card) that allows users of the app easy access to their cash balance. In the third quarter, revenue from Instant Deposit, Cash Card, Caviar, and Square Capital were the largest contributors to growth in subscription and services revenue , which nearly tripled to $166 million.

Expanding the ecosystem to banking

As you can probably tell, Square is starting to displace traditional money management and banking services, which spells a huge growth opportunity. Serving the underbanked is a goal of both Square and PayPal , but I think banks have more to fear about Square's recent growth and future ambitions.

During the third-quarter conference call, management cited three areas of focus heading into 2019: omnichannel, international, and banking services. In December, Square applied for a bank license to accept customer deposits, a sign that management is moving aggressively forward with plans to disrupt traditional banking.

Going after banking services not only significantly expands Square's addressable market, but it also is a natural extension of where Square's business is already moving. More people are using peer-to-peer payment apps to shop in grocery stores and restaurants and pay back others for lunch. It just makes sense that if more people are starting to hold more cash in the Cash app -- using it as a bank -- Square might as well try to treat those balances like deposits and revolutionize the banking industry in the process.

Square sees other opportunities to expand into banking services. Recently, Square announced the new Square card for merchants that gives sellers immediate access to cash after a sale.

The new Square card for merchants is a game changer. Not only does it incentivize sellers to keep their cash within the Square ecosystem instead of transferring the balance to a bank, but Square is essentially offering sellers who use their Square card a rebate for point-of-sale transaction fees. When a seller uses their Square card to transact with another seller in the Square ecosystem, they get a 2.75% discount on their purchase -- the same fee Square charges sellers for point-of-sale transactions.

With services like this, Square is making it very difficult for small business owners to use competing services from larger financial institutions. On the third-quarter conference call with investors, former CFO Sarah Friar mentioned that Square is positioned to not only grow into new markets, such as mobile payments, but also take share away from larger financial service firms: "I think one place that folks often underestimate Square though is by just looking at current market and imagining the share we could take from that, rather than thinking about greenfield opportunity."

Explosive growth doesn't come cheap

Square is already enjoying plenty of momentum to drive strong growth with existing services. However, it's exciting to see the company continuing to find new ways to keep building out the ecosystem and creating new ways to monetize and incentivize further transactions across its platform. Just think about this: One analyst estimates that Square's addressable market specifically with the new business debit card is about $50 billion. Square's trailing-12-month total revenue is $2.98 billion. Add in the company's opportunity with its existing services, and we have the makings of a multibagger stock.

I own shares of PayPal and like the company's growth prospects, but if you want a stock that could add some juice to your long-term returns, you might want to consider Square. Of course, with recent high growth rates and a massive growth opportunity, the stock isn't cheap. It currently trades around 107 times forward earnings estimates.

On the other hand, with management's guidance of at least 40% growth on the top line this year, and analysts' average forecast for earnings to grow 52% per year over the next five years, the valuation may not be far off the mark.

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John Ballard owns shares of PayPal Holdings. The Motley Fool owns shares of and recommends PayPal Holdings and Square. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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