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Does Square Belong in Your Portfolio?

Square (NYSE: SQ) is a unique company. On one hand, it's a digital payments network that has been deeply affected by the pandemic. As the economy gradually reopens and recovers, Square and the myriad merchants that rely on its services will recover too. But on the other hand, Square is a top financial technologist that has gotten a big boost in the last year from social distancing, remote work, and the like -- and all of the changes in the economy that have ensued.

A year from the start of the pandemic, Square's stock is up some 160%. A great deal of expected growth is priced in, but this stock deserves to be a part of growth investors' portfolios.

An economic recovery play

Square divides its business into two basic segments: Its namesake seller ecosystem that works primarily with merchants, and the more consumer-oriented Cash App.

First, let's take a look at the seller ecosystem. Though many of its customers were deeply affected by the pandemic, Square has quickly rebounded here and returned to year-over-year growth. Notably, even though a second round of lockdowns was enforced in some areas in the final months of 2020, Square still added more customers and grew both its revenue and gross profit in the fourth quarter. Retail has quickly migrated online, and Square's diverse mix of online and in-person channel management has helped.

Metric

Q1 2020

Q2 2020

Q3 2020

Q4 2020

Seller ecosystem revenue

$853 million

$723 million

$965 million

$987 million

YOY change

16%

(17%)

5%

5%

Seller ecosystem gross profit

$356 million

$316 million

$409 million

$427 million

YOY change

18%

(9%)

12%

13%

Data source: Square. YOY = year-over-year.

As the economy finds its way forward in this new normal, Square's seller ecosystem is in line for a big rebound.

Image source: Getty Images.

A more speculative play on the future of financial services

Then there's Cash App, sparring with PayPal's Venmo for dominance in the mobile money management space. Though it trails Venmo in monthly active users (Square reported 36 million active users at the end of 2020 compared to just shy of 70 million at Venmo), it does have the edge in many capabilities. Cash App is creating a new generation of investors as it includes functions to buy and sell Bitcoin and individual stocks and ETFs. New features are being tested, like micro loans, and Square recently acquired the online tax prep business from Credit Karma. Put another way, Cash App is building out a platform to give traditional financial services firms a run for their money.

Including Bitcoin revenue and gross profit (which were $4.57 billion and $97.0 million, respectively, in 2020), Cash App had a banner year by all accounts.

Metric

Q1 2020

Q2 2020

Q3 2020

Q4 2020

Cash App revenue

$528 million

$1.20 billion

$2.07 billion

$2.17 million

YOY change

197%

361%

574%

502%

Cash App gross profit

$183 million

$281 million

$385 million

$377 million

YOY change

115%

167%

212%

162%

Data source: Square.

With or without Bitcoin, Cash App is clearly generating massive growth for Square and leading the charge in next-gen banking and financial services. While investors wait for the seller ecosystem to start lapping depressed 2020 financial results from the start of the pandemic, the mobile money application segment is a real differentiator here.

Does it belong in your portfolio?

Square is going to be a volatile stock. Given its large investment in Bitcoin, changes in the cryptocurrency's price could cause similar fluctuations in Square stock -- both up and down. This is also a fast-expanding fintech outfit that is funneling much of its profit back into marketing and development to maximize its growth. Quarterly fluctuations in its reported growth will also cause shareholders some headaches.

Nevertheless, this is an exciting business to be invested in -- if you're in it for the long haul, like five years or more -- as it disrupts the status quo in banking and financial services. I prefer Square stock as an alternative to owning Bitcoin directly, as the company is using digital currency as a marketing tool, to jump-start its investment platform, and to otherwise create next-gen digital payment infrastructure (I like businesses that do things with assets, rather than owning the raw asset directly). Square also has a lot riding on the gradual reopening of the economy as consumer activity normalizes -- whatever that will look like in the years ahead.

At just over 11 times trailing 12-month sales (or 22 times trailing 12-month sales when excluding Bitcoin revenue), shares are still a good long-term value, in my view, for those willing to ride out the inevitable ups and downs.

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Nicholas Rossolillo owns shares of PayPal Holdings and Square. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends PayPal Holdings and Square. The Motley Fool recommends Bitcoin and recommends the following options: long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.


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