One of the best performing stocks this year has been Square Inc (NYSE:SQ). SQ stock has more than doubled as trends in mobile commerce have caught fire, and Square has proven itself as a company with secular growth potential.
But has this growth stock topped off? Or is there more room to run for investors who are late to the party?
Naturally, valuation is a concern considering SQ stock is trading at over 100 times forward earnings. But much like its hyper-growth peers, Square deserves that rich valuation. The company is successfully positioned in a secular growth market. Revenues are exploding higher. Margins are expanding. Earnings are about to turn positive and head materially higher.
So can SQ stock keep heading higher?
I think so.
Square Is Attacking a Big Market
Square is a company with a market cap of nearly $12 billion. That seems expensive considering sales estimates for next year sit at around $1.2 billion. A forward price-to-sales multiple of about 10 doesn’t scream value.
But Square is going after really big markets — and growing rapidly in those markets.
Payments processing is about a $26 billion-and-growing market. Square is grabbing only a tiny piece of that pie, but its market share is rapidly increasing. Gross payment volume has been growing around 30% to 40% per year.
These huge market share gains will almost certainly continue over the next several years.
Why? Mobile.
Mobile commerce, or m-commerce (as industry insiders like to dub it), is one of the biggest trends in retail right now. Phones have gone from communication devices to all-in-one personal assistants. This transition encompasses phones acting as wallets and registers. Square’s technology enables this transition. Thus, as more and more transactions go mobile, more and more payment volume will flow through Square, the most popular player in the mobile payments processing world.
But that $26 billion revenue opportunity isn’t even close to Square’s total addressable market. Square is plunging into markets which complement its core payments processing business. These markets include small-business loans (Square Capital and Square Financial Services) and food delivery (Caviar), among others.
All together, Square management believes the addressable market is around $60 billion.
This is why Square management also believes they can grow revenues around 20% to 25% per year in the long-term. Assuming revenues hit consensus estimates this year and grow around 22.5% per year after that, SQ is looking at revenues of around $2.6 billion in 5 years — and that would still represent only 4% market penetration.
Bottom Line on SQ Stock
In other words, Square’s runway for growth is very, very long. Revenue growth rates north of 20% are here to stay for a while. Meanwhile, EBITDA margins are expected to expand from about 12% today to 37.5% in the long-term.
Huge revenue growth on top of huge operating leverage implies tremendous growth prospects for this company. Granted, a lot of this growth is already priced into the stock, but compared to many of its high-growth peers, SQ stock still has room for valuation expansion.
Square stock is trading around 46 times fiscal 2019 earnings estimates. That’s expensive, but not nearly as much as investors are paying for other hyper-growth stories. Amazon.com, Inc. (NASDAQ:AMZN) trades around 70 times fiscal 2019 earnings estimates. Netflix, Inc. (NASDAQ:NFLX) trades around 59 times fiscal 2019 earnings estimates. Shopify Inc (US) (NASDAQ:SHOP) trades around 130 times fiscal 2019 earnings estimates.
So can SQ stock head higher? I think so. The underlying secular growth trends in mobile commerce are strong. The company is tapping into only a small portion of its addressable market. The growth runway looks promising. And the stock is more cheaply valued than similar secular growth peers.
Maybe wait for a pullback, but SQ stock will head significantly higher in the long run.
As of this writing, Luke Lango was long SQ, AMZN, NFLX, and SHOP.
