Please ensure Javascript is enabled for purposes of website accessibility

What's Behind Square's Stellar Fourth Quarter?

By Adam Levy - Mar 1, 2017 at 7:59PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Square's adjusted EBITDA margin exploded.

Square (SQ 5.54%) closed out 2016 in fine fashion. For the fourth quarter, the payments company generated a loss per share of $0.04 on revenue of $452 million. That's a much narrower loss than the $0.09 per share analysts were expecting, and a modest beat on the top line as well. Square also reported adjusted EBITDA of $30 million, well above its guidance of $16 million to $18 million.

Square's margin expansion is encouraging for patient investors. Adjusted EBITDA margin improved a whopping 20 percentage points year over year last quarter, to 16%. "This improvement reflects strong top-line growth, and benefits from improved operational efficiency and ongoing improvements in our risk management," CFO Sarah Friar told investors on the company's fourth quarter earnings call.

Let's dig into the specifics as to what's driving Square's stellar performance.

Square register running on a laptop and smartphone

Image source: Square.

Square Capital

One of the biggest contributors to Square's earnings beat was Square Capital. "We saw very strong seasonality in Capital, when we had expected it perhaps to drop off more toward the end of the year," Friar told analysts.

Square facilitated 40,000 business loans totaling $248 million in the fourth quarter. That's an increase of 68% year over year. Importantly, Square has been able to grow its lending service without taking on unnecessary risk. Default rates remained below 4%.

At the same time, Square isn't having trouble finding investors to back its loans, which allows it to grow as much as it wants. Square faced some difficulties at the beginning of 2016, but all of those issues seem to be resolved. "We have a very healthy group of investors in place today that can absolutely meet the capacity for growth for Capital for 2017. And we have a list of investors who would like to get in on the program, too," Friar said.

Other new products

Square made a big point of highlighting the strength of its newer products, i.e., products launched in 2014 or later. These new products accounted for 14% of total revenue and 25% of adjusted revenue in the fourth quarter.

Most of Square's new products fall under subscription and services revenue, which is a recategorization of Square's software and data segment. Square Capital accounts for a large portion of the subscription and services revenue, but the segment also includes Caviar -- its food delivery platform -- as well as Invoices. Overall, the segment grew 81% year over year.

The outsized growth of these new products is important because they carry higher margins than Square's core payments service. As a result, Square's margins continue to expand. Square guided for another 5 percentage point adjusted EBITDA margin expansion in the first quarter.

Room for improvement

Square is starting to show a little bit of operating leverage, but there's a lot of room for improvement as the company continues to scale. For the full year of 2016, operating expenses represented 43.7% of revenue in 2016, compared to 43% for all of 2015. That improved in the fourth quarter, when Square spent 39.9% of revenue on operating expenses, versus 41.9% the previous year.

The trend started moving in the right direction in the fourth quarter. For the most part, though, Square's improving operating margin is being driven by the higher gross margin products discussed above.

Investors shouldn't expect margins to expand overnight, though. Square continues to plow money into marketing in order to attract more merchants. As long as it's seeing a consistent return on investment, there's no reason it should slow down. Expect Square to stick closely to its 5 percentage point EBITDA margin expansion guidance and invest anything extra back into growing the business.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Block, Inc. Stock Quote
Block, Inc.
SQ
$71.00 (5.54%) $3.73

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
321%
 
S&P 500 Returns
111%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 06/25/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.