For those who follow digital payments processor Square Inc (NASDAQ:SQ), this week has been an intense showdown between Bull and Bear.
Playing the part of bear is BTIG’s Mark Palmer, who recently reiterated his “Sell” rating on Square stock and slapped a $30 price target on SQ (more than 30% downside). Palmer thinks that an irrational pairing with bitcoin is keeping Square stock afloat. He expects that pairing to break soon, and for competitive pressures to rise rather quickly, the combination of which will unravel the valuation on SQ stock.
Playing the part of bull are KeyBanc’s Josh Beck and Nomura’s Dan Dolev. Beck argues that the company’s strong sales traction among large sellers will continue, while cross-selling opportunities remain promising. He has a $52 price target on Square stock (16% upside). Dolev argues that Square, as a leading player in a hyper-growth market with longevity, draws comparisons to the early days of Amazon.com, Inc. (NASDAQ:AMZN) and Alphabet Inc (NASDAQ:GOOG)(NASDAQ:GOOGL). He has a $64 price target on SQ stock (40%-plus upside).
So who’s right? Is this an overvalued stock set to crumble as competition rises? Or is this a secular growth stock still in its early innings?
I think the latter. Here’s why.
Why Bull Beats Bear on Square Stock
The bear thesis on Square stock hinges on three main principles:
- Square stock is being propped up by irrational bitcoin sentiment tailwinds.
- Competition will inevitably erode growth rates.
- The current valuation is nonsensical.
But I don’t think any of these arguments hold much water in the big picture.
Firstly, Square stock isn’t being propped up by irrational bitcoin sentiment tailwinds. While the bitcoin and SQ charts do look similar since January 31, that is what essentially every tech stock chart looks like in that same time frame. The markets (and bitcoin) dropped big in early February. But each found a bottom a few days into February, and it’s been a rally for everyone since then.
Indeed, SQ stock bottomed on February 9 with the broader stock market, not on February 6, when bitcoin bottomed.
Secondly, competition is nothing new for Square, and it hasn’t, isn’t, and won’t derail the growth narrative. BTIG highlights rising competition from First Data Corp (NYSE:FDC), pointing to the company’s Clover and Clover Go solutions as competitive risks that could knock the SQ growth narrative off course.
But Clover is nothing new. Clover’s annualized gross payment volume is $50 billion. Square’s annualized gross payment volume isn’t much bigger at $70 billion. Moreover, Clover GPV is growing at a 50% and rapidly slowing rate (quarterly year-over-year growth has fallen from 75% two quarters ago). Square’s GPV is growing at a 30% and marginally slowing rate.
In other words, for the past several quarters, Clover has had tremendous scale and huge growth and that still hasn’t watered down Square’s results by all that much. GPV growth at Square has gone from 34% to 31% over the past four quarters. Clearly, digital payments processing is a secular growth market wherein multiple players can grow alongside one another. This is very similar to the digital advertising and e-commerce markets that Google and Amazon now dominate.
Thirdly, the current valuation makes sense if you start looking at estimates that are several years out. This is a 30%-plus and accelerating revenue growth company with a huge addressable market and multiple cross-selling opportunities. Margins are zooming higher, and should continue to zoom higher as revenue scale drives expense leveraging. Earnings are expected to rise 80% next year to $0.45, and nearly 70% the following year to $0.75.
At that point in time, revenue growth will likely still look like 30% given the huge addressable market, which management pegs at $60 billion, including cross-selling opportunities — for perspective, revenues are expected to be less than $1 billion this year. Margin drivers will remain in place thanks to the still huge revenue growth, so you’re talking about a 50%-plus earnings growth company.
Paypal Holdings Inc (NASDAQ:PYPL) is trading at 34-times 2018 earnings for a 19% long-term earnings growth rate (80% premium). Visa Inc (NYSE:V) is trading at roughly 27-times 2018 earnings for a 18% long-term earnings growth (50% premium). Apply that average premium (65%) to 50% earnings growth, and you get a fair forward multiple of 82.5. An 82.5 forward multiple on 2019 earnings estimates of $0.75 implies a 2018-end price target of over $60.
Bottom Line on Square Stock
I’m not so sure this company has the growth potential of a Google or an Amazon. But I am sure that this is a secular growth company whose stock has a lot of room to run higher as the company grows into its valuation.
As of this writing, Luke Lango was long SQ, PYPL, AMZN, and GOOG.
