After the company rolled out the ability to buy and sell bitcoin through its app, digital payments processor Square Inc (NYSE:SQ) stock soared. In just over a week, SQ stock zoomed from $40 to $50.
But then Square stock got punished. Badly. In the the week after SQ stock took off from $40 to $50, it dropped from $50 to just under $37. It was wild move. Go look at the stock chart for Square during November 2017. It looks like the Eiffel Tower.
Square stock kept grinding lower in December, albeit at a slower rate, all the way down to under $35.
But 2018 has been a fresh start for Square stock. It already is up 20% in just over a week and back above the $40 level.
Fundamentals tell me that this rally in SQ stock can continue. Here’s a deeper look at why.
A Healthy Long-Term Growth Narrative
Square is a secular growth stock supported by strong fundamentals. It is more or less a pure play on the secular growth in digital (and more specifically mobile) commerce. Today, as opposed to requiring several moving parts to support digital and card payments, all retailers need to complete essentially any transaction is a phone and Square technology.
The more and more transactions go cashless, the more and more payment volume will flow through Square.
This market is quite big, and Square is tapping only a small portion of it. Payments processing is a $26-billion-and-growing market. With the addition of ancillary markets like small-business loans and food delivery, Square believes its total addressable market is around $60 billion.
Revenues this year are expected to be under $1 billion.
Considering Square is tapping less than 2% of its addressable market, big growth is here to stay.
This thesis is further supported by Square adding cryptocurrency compatibility. As I’ve said before, Square isn’t getting into the cryptocurrency game to validate blockchain technology or support bitcoin. It’s getting into the cryptocurrency game to match booming consumer demand.
The move underscores the company’s unparalleled ability to innovate in the payment processing space. That is a good thing which means Square should be able to post big growth into the foreseeable future through new product rollouts and innovative solutions.
All told, earnings growth is expected to be 75% next year and 65% the year after that. Given secular tailwinds and the company’s proven ability to adapt to changes in consumer demand, that growth won’t come unhinged any time soon. At worst, growth falls to 45% to 2020 and 25% in 2021. That would imply a 35% annualized earnings growth rate from 2019 to 2021.
Right now, lower growth peer Paypal Holdings Inc (NASDAQ:PYPL) is trading at a 100% premium to its growth prospects (42-times this year’s earnings for 21% growth prospects).
SQ stock in two years easily deserves that same premium, which would imply an earnings multiple of 70. A 70-times multiple on fiscal 2019 estimates of $0.75 implies a 2-year forward price target of $52.50. Discount that back by 10% per year, and you get to a $43 present value on Square stock.
And that is a low estimate. More likely, growth looks like 40% per year from 2019 to 2020. A 40% growth rate would lead to a fair multiple of 80, a 2-year forward price target of $60, and a present value of nearly $50.
Bottom Line on SQ Stock
This stock is a long term winner.
The only question about SQ stock is valuation. I feel exceptionally comfortable with Square stock from a valuation standpoint below $43. I also think this stock has fundamental runway to $50.
And that is why I’m sticking with the rally here. It is a big growth stock trading at a reasonable valuation that has room to expand.
As of this writing, Luke Lango was long SQ.
