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This Stock Has Doubled in Less Than a Year -- but Could Still Be a Smart Buy

By Matthew Frankel, CFP® - Updated May 5, 2017 at 4:52PM

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This financial technology company has barely started to realize its potential.

Last May, payment-technology company Square (SQ -5.52%) saw its stock price drop to less than $10 per share after it posted less-than-stellar results. Since that time, however, Square has produced some pretty impressive results and its stock price has more than doubled. Here's what you need to know about Square's impressive start to 2017, and where it could be heading from here.

SQ Chart

SQ data by YCharts.

Square's first-quarter results beat expectations

For the first quarter of 2017, Square beat expectations for the third consecutive quarterly report. The company's loss of $0.04 per share was narrower than the $0.08 analysts had been projecting, and revenue of $461.6 million came in about $11 million higher than estimates.

Square payment processing equipment used in a small business.

Image source: Square.

Transaction-based revenue, which makes up about 87% of the company's total, came in higher than expected, but the smaller subscription and services-based revenue stream was a particularly bright spot in the report, smashing expectations by a 19% margin.

As a result of the strong quarter, Square raised its full-year guidance for earnings per share to a range of $0.16 to $0.20, one cent above the previous range, and also increased its revenue guidance range by $10 million.

Impressive growth in recent years

Over the past couple of years, Square has done an excellent job of getting U.S. small and medium-sized businesses to use its product. In fact, just before I started writing this, I paid for coffee at a local independent coffee shop through a Square payment system.

Square's year-over-year growth is extremely impressive, with a 33% rise in payment volume to $13.64 billion. Revenue increased 22% from last year, and while the company lost $97 million in 2016's first quarter, it is now on the verge of becoming profitable.

Bar chart of Square's payment-volume and revenue growth, and narrowing losses

Image source: Square 1Q17 letter to shareholders.

Not only did Square's payment volume increase, but the company's profit margin did as well. Transaction-based profit margin as a percentage of payment volume increased from 1.03% last year to 1.07% last year. Generally speaking, a combination of revenue growth and margin expansion is great news for investors.

In addition, Square's subscription and services-based revenue, which I mentioned earlier as a highlight of the quarter, grew by an incredible 106% year over year, and it still has lots of potential to grow.

This growth story might be just getting started

Despite the strong growth so far, there are several reasons to believe that Square's growth is still in the early innings.

For starters, Square just recently (in March) expanded its operations to the U.K. Despite being in a market where 70% of shoppers prefer to pay with a card, more than half of the country's small businesses don't yet accept credit card payments. Since the U.K.'s small and medium-sized businesses generated 1.8 trillion pounds in revenue in 2016 (about $2.3 trillion U.S.), it's fair to say that this is a pretty large-scale opportunity.

That's in addition to the opportunities that remain in the U.S. Square's payment-processing volume still represents a very small fraction of its addressable market, and the company is venturing into industry-specific solutions, like its Caviar pickup service aimed at independent restaurants. Consumer spending at U.S. independent restaurants is estimated at $230 billion annually, so there's lots of potential to grow this and other industry-targeted ventures.

Also keep in mind that Square is only in four countries so far. Two-thirds of businesses in the world don't yet accept payment cards, so there's significant room for international expansion. The traditional way of accepting cards (hardware, software, and services) is prohibitively expensive and complex for many of these businesses, and Square aims to offer an alternative approach. By 2025, it is estimated that international card payment volume will reach $45 trillion annually. That's a massive market opportunity. Even if Square can capture just 1% of that, it will be roughly ten times the payment volume it processes now.

The bottom line is that Square is on its way to being a major player in the worldwide payment-processing industry, and is still worth a look even after the stock price gains.

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