Square Stock Is a Long-Term Winner, Despite Valuation Risks

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High-growth stocks have run into a brick wall this earnings season. First, it was Netflix (NASDAQ: NFLX ). Then, it was Facebook (NASDAQ: FB ). More recently, it was Twitter (NYSE: TWTR ).

But payments processor Square (NYSE: SQ ) has bucked that trend. The company reported blowout earnings after the bell on Wednesday, and SQ stock popped as much as 8% in response.

The numbers illustrated that SQ stock's biggest secular growth driver - the shift towards cashless and digital payments - isn't slowing down at all. As such, payment volume growth, revenue growth, and profit growth all remain as robust as ever at Square.

What is next for SQ stock? The shift towards cashless and digital payments is a huge secular growth narrative with multiple big growth years ahead. Consequently, SQ stock is one of those long-term winning investments that investors should own for the long haul.

At current levels, though, valuation seems a bit tricky. Thus, SQ stock may run up against some valuation friction in the near-term. But, such friction should be viewed as a buying opportunity. This one is going way higher in the long-term.

Here's a deeper look.

Square Earnings Were Really Good

SQ stock initially dropped after second-quarter earnings were released because the third-quarter guide was slightly disappointing.

But, a slightly lower-than-expected third-quarter guide is rather meaningless in the big picture. What matters is that adjusted revenue growth accelerated to 60%, from 51% last quarter and 41% in the year-ago quarter. What also matters is that gross payment volume growth was steady at 30%, that Caviar revenue doubled year-over-year, that subscription revenue more than doubled year-over-year, and that adjusted EBITDA margins zoomed to 18% - from 15% a year ago.

In the big picture, then, all is well in the Square kingdom. Gross payment volume growth is big and steady. Revenue growth is accelerating - thanks to rapid growth in Caviar and the company's subscription services. And, margins are trending higher with scale.

Until revenue growth, gross payment volume growth, or margin growth meaningfully decelerate, SQ stock will head higher. That is simply how high-growth stocks operate.

Buy Big Dips in Square Stock

Having said that, SQ stock does look a bit overvalued in the near-term.

Square is powered by a secular growth narrative wherein the payment process is not only going cashless, but also going digital, removing friction, and becoming much simpler. Square is at the heart of all these transitions, and is enabling a new era of cashless, digital, and simple commerce that will become the norm in the foreseeable future.

Square's addressable market is quite large. It includes all consumer spending globally, which was $28 trillion in 2010 and projects to be $40 trillion by 2020. Granted, Square won't be able to tap into a huge portion of that market because the company deals specifically with retail, food, and consumer-facing services. But, Square doesn't need a large slice of a $40 trillion market to warrant a higher stock price.

Square currently controls about 0.2% of the global consumer spend market. I think that figure can realistically grow to 1% over the next several years as Square machines and processes are implemented in greater frequency across the globe. Sizable market share gains in global commerce, coupled with robust subscription services growth, lead me to believe that Square can do about $8.5 billion in adjusted revenues and $5.20 in earnings per share in seven to 10 years.

Payment peers PayPal (NASDAQ: PYPL ) and Visa (NYSE: V ) have both historically traded around 25X forward earnings . An industry-average 25X multiple on $5.20 in earnings per share implies a long-term price target of about $130 for SQ stock. Assuming SQ stock gets to $5.20 in earnings per share in seven to 10 years, that implies a year-end price target of anywhere from $60 to $80.

Thus, I am comfy with SQ stock around $70.

Bottom Line on SQ Stock

This a high-growth stock powered by strong long-term drivers. But, SQ stock does look slightly ahead of itself after this big earnings pop.

Thus, there may be some near-term noise. But, such near-term noise should be viewed as nothing more than an opportunity to add more for the long haul.

As of this writing, Luke Lango was long FB and PYPL.

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The post Square Stock Is a Long-Term Winner, Despite Valuation Risks appeared first on InvestorPlace .

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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