The Strategist

Is it worth buying shares of Square?


12/05/2017 - 11:51



Over the past 18 months, shares of Square have risen more than 400%. The company has repeatedly outperformed forecasts for revenue and profit, while significantly increasing the EBITDA margin.



The last quarterly report, together with the news that Square is experimenting with the crypto currency, caused a sharp jump in the company’s shares to record highs. Given the high price of shares, investors are wondering: Is it wise to buy them now, despite all the company's achievements?

Does Square have a serious advantage?

The number of competitors in the field of solutions for receiving and processing payments for small businesses is constantly growing. Square entered the market at the beginning of the decade. PayPal, Intuit and Shopify are also active here. The latter mainly offer software solutions, but has managed to enlist the support of millions of small and medium-sized enterprises. In addition, dozens of foreign companies work outside the United States - Square will have to compete with them when trying to enter the markets of other countries and attract large customers. Thus, the company needs a serious competitive advantage - an "economic moat" (a term popularized by Warren Buffett).

The main advantage of Square is the growing ecosystem of applications and tools that work together with the main payment processing service. Indeed, customers using several of the company's products at the same time - for example, the payment system, the Square Capital small business loan service, and the payroll management service - will face serious difficulties in moving to a competing platform. However, such an approach can hardly be called a serious "moat", since it has both pluses and minuses. PayPal, Intuit and Shopify offer their own unique business solutions, and some of them are much better suited to customer needs than Square’s products. In other words, the company's additional services do not necessarily attract new customers.

All this is reflected in the gross profitability of Square, which numbered 37% in the last 12 months. The corresponding indicators of Shopify and Intuit are at 56% and 84%, respectively. The sale of equipment brings Square insignificant losses, but the profit from basic operations still does not allow reducing the gap between the company and its competitors.
 
Rapidly growing business

Despite the weak competitive advantage, Square manages to maintain high growth rates. The company invests heavily in new services and the expansion of existing products to meet customer needs. This supports their loyalty and increases the income from each buyer. This strategy helps to cope with the growing competition, because the company does not have other serious advantages.

In addition, Square spends a lot of money on advertising, trying to enter foreign markets and cope with new rivals. Efforts pay off higher than expected revenue growth. During the press conference on the results of the third quarter, management confirmed plans to increase profitability and increase revenues in the next few years (adjusted revenue grew by 45% in the previous quarter).

Analysts predict that in the next year the total revenue of Square will jump by 30%. According to their estimates, the company will be able to maintain such growth rates within the next five years. Gross profitability can increase due to the transition to more profitable subscriptions and services - gradually the company will refuse only the processing of payments.

A look at the estimates

Square is growing steadily and is working to expand its competitive advantage. However, the demand for its shares depends on its price.

Here is a comparison of the ratio of the company's current value to sales for companies in the industry:

Square - 9
PayPal - 7,3
Shopify - 17,5
Intuit - 7,5

Square is much more expensive than PayPal and Intuit, but almost twice inferior to Shopify. Given the faster projected growth rates than the two largest competitors (PayPal and Intuit), the company's shares should be traded with some premium. On the other hand, Square has not yet achieved breakeven under GAAP standards, while PayPal and Intuit are already showing excellent results.

After the recent take-off, the company's shares are traded at high prices, which makes their purchase much more risky for investors. Square does not have a serious competitive advantage, its growth depends on the successful entry into very complex markets, so there is high uncertainty about the shares. The management did an excellent job, expanding the offer of products and strengthening the market share of the company, but there is no guarantee that Square will be able to maintain its momentum. The company's shares are well suited for buyers willing to take on an increased risk. 

source: fool.com




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