Collectively, Square (NYSE:SQ) has been one of the year’s hottest tech stocks. It sits at the perfect juncture of finance, e-commerce and technology — and this has allowed Square to be a natural winner coming out of the novel coronavirus. And while SQ stock bottomed around $32 per share in March, its shares have more than tripled since then. Traders had originally feared that Square would be crushed as small businesses closed down. However, the success of Square’s Cash App has made up for that risk and more.
So, for new investors, is it too late to get onboard?
Well, while Square certainly isn’t as cheap as it was, the company could still be in the early innings of a long and fruitful story. And it all starts with the company’s platform.
Square Started With Payments
Overall, Square is a leading payment processor that is attempting to become the go-to digital bank for tech-savvy clients. It is doing this by building out its digital wallet capabilities.
From its inception, Square has provided payment-processing services to small merchants. It got its start with a point-of-sale hardware device, which allowed small merchants such as taxi drivers, hairstylists, massage therapists and so on to process credit card payments.
Additionally, Square has built on that success by offering a mobile app that broadens its payment-processing capabilities.
This business grew rapidly for many years, but has been slowing recently. The coronavirus has caused a notable slowdown, as Square’s payment volumes rolled into negative territory this past quarter. That’s understandable, as many small businesses had to suspend operations due to the virus. Fortunately for shareholders, though, Square has other plans in addition to the payments business.
A Payments Player Expands Its Ecosystem
Most importantly, the company operates fast-growing digital banking services via its Cash App. And because this business has been growing at triple-digit rates year-over-year, it now accounts for about one-third of Square’s gross profits.
Cash App is a money transfer platform that allows users to send, store and/or receive cash. There’s more to it than just that, though. Square continues to add features to make it more competitive in the marketplace. And so far, Square’s bitcoin brokerage service has been one of the key features.
Moreover, Square’s huge Q2 revenue beat was primarily driven by far higher-than-expected bitcoin trading on the company’s app. Square earns a 2% commission on these bitcoin trades. Thus, while it isn’t a huge profit center for the company, it’s a fantastic tool for attracting new users to the Cash App.
In all, Square is rolling out plenty of additional features. It has a brokerage that allows users to trade stocks and other regulated financial products. And reports suggest that Square will be launching a direct lending program to consumers soon as well.
Square Becomes an Online Bank
The company has already created quite a financial marketplace on the Cash App, and it’s set to move even further in that direction next year. That’s because, in March, Square obtained its long-awaited banking license.
The Federal Deposit Insurance Corp. (FDIC) approved Square’s application, which means the company can now launch a commercial bank. Opening in 2021, Square’s bank will be based in Utah, and be allowed to receive deposits from its clients. This is a huge step, since Square will be able to pay interest on those deposits and have FDIC insurance for its bank accounts. It is hard to function as a true one-stop digital wallet without that insurance backstop, but now Square will have it.
In addition, the banking license gives Square broad authorization to make commercial loans just as other banks do. This clears up a lot of red tape around Square extending financing to the small businesses that use its payments platform.
Put it all together, and Cash App and related banking functions should account for half of Square’s gross profits within two years. Yes, there’s much more here than just the payment-processing angle nowadays.
SQ Stock Verdict
Collectively, if Square can execute on Cash App and the banking platform, it will deliver huge gains. That said, don’t overlook its peers. Online payments and banking will be a huge market in the future. As such, there is plenty of competition vying to become consumers’ first choice in digital wallets.
In fact, this is the biggest risk to SQ stock. Square competes against PayPal’s (NASDAQ:PYPL) Venmo app, Zelle, Apple (NASDAQ:AAPL) Pay and more.
These are all sophisticated offerings from large and well-funded competitors, and Square has made its mark against these rivals so far. However, there’s no guarantee that it will remain the leader forever.
Another risk is that the company is prioritizing revenue growth and market share over profitability. Some of Square’s recent moves, such as bitcoin trading, have added far more revenues to the top line than actual operating profits. In turn, the assumption is that Square can generate more profitability over time as customers become more comfortable with Cash App. Still, though, Square hasn’t yet proven that its new trading clients will eventually transition into higher margin services.
Even so, Square has been generating robust free cash flow. And assuming the company’s core payment-processing business maintains slow and steady growth once the pandemic passes, Square should be set to go. The digital banking business can generate high double-digit growth, making SQ stock a winner.
Eric Fry does not own the aforementioned securities.
Eric Fry is an award-winning stock picker with numerous “10-bagger” calls — in good markets AND bad. How? By finding potent global megatrends… before they take off. And when it comes to bear markets, you’ll want to have his “blueprint” in hand before stocks go south.
