Square Inc (SQ) Stock Wants to Breakout to New Highs Despite Year’s Gains

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Square Inc (NYSE:SQ) has been a beast this year, rallying an insane 95%. In February, the shares broke out over $15 — gapping up to $17 — and it hasn’t looked back since. Given that SQ stock has more than doubled in the past 12 months, many investors feel they have missed the boat. That’s not the case, though.

Square Inc (SQ) Stock Wants to Breakout to New Highs Despite Year's Gains

When a stock goes from ~$10 to $25 in the span of a year, valuation becomes an obvious concern. With SQ stock trading at a whopping 61 times forward earnings estimates, it’s surely not cheap.

However, it may not be as straight-forward as one would think. For instance, SQ trades at 5.3 times last year’s sales, or the price-to-sales (P/S) multiple. That in itself also seems high. However, PayPal Holdings, Inc. (NASDAQ:PYPL) — considered by many as the blue-chip stock in peer-to-peer money sending and online payments — trades even higher, at 6.3 times sales.

Investors could easily make a case for both. On the one hand, bullish SQ stock investors could say the stock is undervalued compared to PYPL, as SQ has superior growth. As a result, it should at least trade with the same P/S. That said, PayPal is no slouch either. Its revenue growth hovers near 18% for this year and next year, the company is profitable and earnings are growing north of 20%. It deserves its premium some might argue.

As a result, PYPL stock is up 45% in the past six months.

I wouldn’t say SQ should necessarily trade at the same valuation as PYPL, as PayPal’s profitability does goes a long way. That said, SQ isn’t that profitable and as a result, I feel an earnings-based valuation is the wrong metric. While that’s not a major offense, it does make it harder to value the company. At least near today’s valuation on a sales basis, SQ can justify its current stock price.

The Square Business

SQ has built a powerful brand blending the POS terminal, an easy-to-navigate user interface and an ecosystem with useful applications. Because of this ecosystem, SQ is able to do more than just give away the razor (terminal or card reader) and continually sell blades (charge fees for each swipe).

Instead it has several services for small- to medium-sized businesses (SMBs) — including bookkeeping, payroll, invoices, and restaurant management. This makes life easier for business owners, but also helps retain customers and make more money for Square. This razor/razor-blade plus subscription model is excellent. Particularly in a mobile-first world in a country that thrives on SMBs.

Square has been investing heavily in the business (more on that in a second), but it’s also finally seeing operating cash flow (OCF) make strides. No, the company has not been profitable for a full fiscal year. But many young companies shooting for growth rarely are. Instead, follow the cash.

In the 12 months ending in December — so fiscal 2016 — Square had OCF of $23 million. This was up about $2 million from the prior year and up significantly from the negative $122 million in OCF in fiscal 2014. However, in the first quarter of 2017, SQ has generated $44 million in OCF. After the second quarter numbers were in, that number swelled to $90.6 million in OCF.

 

That’s a great development and tells us the business is moving in the right direction.

SQ stock chart
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Source: Chart courtesy of StockCharts.com

Final Thoughts on SQ Stock

 

SQ is investing heavily in its business, noted by the $241 million draw on cash so far this year thanks to investment activities. Square has been focusing more on the lending business and even more recently on the banking business. On Sept. 6, SQ announced its intentions to apply for a banking license in Utah. The segment will be capitalized with $56 million in cash.

With regards to its lending business, SQ can make small loans to stable SMBs. Because of the companies’ receipts in SQ’s system, Square knows the quality of businesses it’s loaning to. That’s a valuable asset — one that many banks likely wish they had. While there are risks with lending, this gives off an almost bread-and-butter “lay-up” vibe for SQ.

Beyond all that, the company’s last quarterly report on Aug. 2 was great. SQ stock actually retreated despite beating on earnings per share and revenue estimates. Management raised guidance, with the lower end of its earnings estimates increasing 31% and the lower end of its revenue guidance increasing about 4%. Management expects earnings to be positive for the year.

A beat and raise and a falling stock price? The way I see it, this gives investors a chance to get on board. SQ isn’t highly profitable — not yet. But its ecosystem and revenue continues to grow at a rapid pace, while net income and OCF trend in the right direction. I would be a buyer below $25.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell did not hold a position in any of the aforementioned securities.

Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell.


Article printed from InvestorPlace Media, https://investorplace.com/2017/09/square-inc-sq-stock-wants-to-breakout-to-new-highs-despite-years-gains/.

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