Strong Q3 Numbers Confirm That Square Stock Will Rebound

It’s been a rough past 12 months for shares of payments processor Square (NYSE:), as slowing growth trends coupled with competition and valuation concerns have caused SQ stock to plunge from an all-time high price tag of $100 back in late September 2018, to a $50 price tag in late September 2019.

Twitter's Been Hot, but Square Stock Still Is the Better Buy

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But, SQ stock is starting to show signs of life again. In early November 2019, the company reported third-quarter numbers that were much better than expected, and broadly eased slowing growth and competition concerns. Square stock popped about 5% to three-month highs in response to the strong print.

Is this post-earnings pop in SQ stock the start of a bigger rebound? Or is it just a head-fake in a stock that’s doomed to head lower?

I think it’s the former. The strong third-quarter earnings report added further evidence to the notion that this company can simultaneously sustain strong revenue growth at scale, while rapidly improving its margin profile. This combination paves the path for Square to generate robust profit growth over the next few years. Some of that profit growth is priced into SQ stock today. Some isn’t. The part that isn’t is what will drive SQ stock higher from here.

The investment implication? Buy into the Square stock rebound. This stock is heading for $70 soon.

Square Earnings Add Credibility to Bull Thesis

In the big picture, Square’s third-quarter earnings report was yet another piece of evidence providing support for the bull thesis underpinning Square stock.

What is that bull thesis? Thanks to secular growth trends supporting broader adoption of non-cash payments globally, Square is well positioned to deliver sustained strong revenue and profit growth for the foreseeable future.

It may sound like a mouthful. But, when you break it down, it’s simple. Consumers everywhere are pivoting to non-cash payments because paying with a card or a phone is so much easier than paying with cash. Businesses globally have to keep up with this pivot. Square builds solutions which allow them to do that. At first, Square simply offered businesses point-of-sale hardware solutions so that they could accept all sorts of non-cash payments. Now, Square has since built out an ecosystem of software offerings complementing the core non-cash payment process, and all of these services feature high gross margins, so scale should ultimately drive big revenues and big profits here.

At this point, the numbers tell the story. Gross payment volume through Square’s ecosystem rose 25% year-over-year in Q3, following 25% growth last quarter. Adjusted revenue growth was yet again in the 40%-and-up territory. Adjusted EBITDA margins expanded more than 500 basis points year-over-year to record highs, continuing what has been a multi-year stretch of margin improvements. The guide calls for all this to continue next quarter.

Square is leveraging product innovation and secular growth tailwinds to sustain big revenue growth at scale and drive margins significantly higher. This trend has been alive for several years now. The more quarters Square turns in like this one, the more likely it appears that this trend will remain alive for the next several years, too.

Square Stock Is Undervalued

Given increased support for the notion that Square will remain a big revenue and profit growth company for a lot longer, SQ stock appears undervalued under $65.

The numbers are simple. Global retail sales are projected to grow at a over the next few years. In 2019, Square projects to own about 0.42% of the global retail sales pie, up from 0.35% in 2018, 0.28% in 2017 and 0.23% in 2016. Thus, thanks mostly to secular tailwinds underpinning non-cash payment adoption, Square has been able to consistently grow share in the global retail market.

This dynamic will continue. Assuming Square continues to expand share at a cadence of 5 to 7 basis points each year, and further assuming that Square’s services ecosystem continues to expand and become more valuable in a non-cash dominated world, then Square should easily remain a 20%-plus revenue growth company for the next several years.

Profit margins should continue to improve. All of Square’s businesses operate at high gross margins. Operating expense growth will be big to support big growth. But, it won’t be 20%-plus big. As such, steady 20%-plus revenue growth on top of sub-20% expense growth should drive healthy margin expansion.

This combination of 20%-plus revenue growth and steady margin expansion should drive somewhere around 30%-plus profit growth. By my numbers, Square will hit $4 in earnings per share by fiscal 2025. Mature payments companies, like Visa (NYSE:) and Mastercard (NYSE:), trade around 30-times forward earnings. Applying that industry-average multiple to $4 in 2025 EPS, you arrive at a 2024 price target for SQ stock of $120.

Discounted back by 10% per year, that equates to a 2019 price target for SQ stock of $75. That’s notably higher than where shares trade hands today.

Bottom Line on SQ Stock

Square stock has been beaten and bruised over the past year, mostly thanks to slowing growth trends giving credence to the idea that competition is killing the Square growth narrative.

But, in the third quarter, growth trends stabilized sequentially. This sequential stabilization in growth erodes the bear thesis which has dominated SQ stock over the past year. Instead, it adds credibility to the idea that Square will sustain large revenue growth at scale for a lot longer.

With respect to SQ stock, the impacts of this are obvious. If this growth stabilization persists — and it should — the past year’s selloff in SQ stock, could turn into a rally over the next year.

As of this writing, Luke Lango was long SQ. 

The post 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.


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