Financial technology (fintech) companies have provided strong returns for shareholders in the last decade, driven by the continued adoption of digital payments and the falling need for cash worldwide. Square (NYSE:SQ) has been one of the big winners to ride this trend with its point-of-sale (POS) and merchant solutions plus the consumer-focused Cash App. The stock price is up a whopping 1,700% in the last five years, greatly outpacing the S&P 500‘s 114% return over that same time period.
The stock has generated such incredible performance to this point that some are wondering if it’s now too late to buy Square stock and continue to benefit? Let’s take a look and see if we can find an answer.
Both of Square’s business segments continue to shine
Square just put out its quarterly report for the three months ending in September. In the period, both its Seller and Cash App ecosystems performed quite well. Seller gross profit grew 48% year over year to $606 million, which shows the recovery of in-person commerce around the country as we slowly move out of the COVID-19 pandemic.
The Seller division made some product announcements last quarter that should give investors confidence in its future growth, too. Square is going to be the exclusive point-of-sale (POS) provider at SoFi Stadium, the new billion-dollar football complex in Los Angeles. It is moving hard into more European countries, with a recent full launch in France and a soft launch in Spain. Accepting payments is needed in every country around the globe, so the more countries Square moves into, the more opportunity it has to land additional customers.
The Seller ecosystem is not just POS solutions, either. In the earnings report, management highlighted the growth of Square Invoices, one of its other services for merchants that helps them easily make invoices compared to legacy solutions. Square Invoices has processed $12 billion in gross payment volume (GPV) in the last 12 months.
The Cash App isn’t growing as fast as the seller ecosystem right now, with gross profit only growing 33% year over year in Q3. However, if you look at the two-year compound annual growth rate (CAGR) that Square provides, the Cash App has grown its gross profit at a 104% rate since 2019, which is phenomenal growth for a business of its size.
Cash App continues to drive engagement with the Cash Card (its free debit card), which is seeing rapid product adoption. According to management, Cash Card users have twice the number of inflows to the Cash App compared to other users, so convincing more and more people to adopt it can help Square grow this division.
On top of the Cash Card, Cash App launched two big products that should drive growth from new and existing users. First, it launched Cash App Pay, an easy way to use a QR code to pay at Square sellers directly from your Cash App balance. Reducing friction like this is a great way to get more and more customer transactions from their traditional bank and credit cards over to the Cash App. Lastly, Cash App is now open for people as young as 13 in the United States. According to management on the conference call, this will expand the Cash App to more than 20 million kids nationwide, and will hopefully be another lever to drive growth over the next five to 10 years.
Acquisition of Afterpay
Square’s two business units are humming along fine at the moment, but it is set to add another one with the proposed acquisition of Afterpay (ASX:APT). The purchase is going to be an estimated $29 billion all-stock deal and brings one of the leading buy now, pay later (BNPL) companies under Square’s umbrella.
Afterpay has approximately 100,000 merchants and 16 million customers using its BNPL product. Square can easily cross-sell its Seller and Cash App services to these separate groups of customers, which could propel Square’s overall growth trajectory. On the flip side, Afterpay will be an easy integration into Square’s existing Seller base, which the company said is currently in the millions worldwide, and within the Cash App, which has over 70 million consumers.
The acquisition is expensive, valuing Afterpay at a trailing price-to-gross-profit (P/GP) ratio of 57, but if Square is able to supercharge the company’s growth by integrating it into the Seller and Cash App ecosystems, the price paid could work out in the long term.
But what about the valuation?
Square’s business is in a great place, but investors should be concerned about the stock’s high valuation. With a trailing-12-month gross profit of $4 billion and a market cap of $104 billion, Square trades at a P/GP ratio of 26, which is rather expensive and will go up once Afterpay is integrated into the business.
Unless Square can continue growing gross profit at 30% to 40% for the next five years and beyond (which it could easily do), it is hard to imagine investors getting outsized returns from the stock. This doesn’t mean Square will be a bad investment, but that investors should temper expectations compared to Square’s historical price performance.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.