Is Square, Inc. a Buy?

Shares of Square (SQ 7.32%)have been on a tear the last 18 months, up over 400%. The company has repeatedly surpassed revenue and earnings expectations, posting wider-than-anticipated EBITDA margin along the way. A recent earnings beat along with news of the company experimenting with cryptocurrency has vaulted the share price to an all-time high.

With shares trading at such a high price, investors interested in the company may be wondering if the stock is worth paying for despite all of its recent successes. 

Image source: Square.

Does Square have a moat?

There's a growing number of competitors in the small-merchant payments processing space Square carved out in the early part of the decade. PayPal (PYPL 2.61%) has been active in the arena, as have Intuit (INTU 1.25%) and Shopify(SHOP 2.59%).While those three are primarily software-based payment processing systems, they already have established relationships with millions of small and medium-sized businesses. Not to mention there are dozens of foreign companies and established point-of-sale system providers that Square will face as it moves to expand its market internationally and tries to appeal to bigger merchants.

As such, it's important Square exhibits some sort of competitive advantage -- a moat. Management points to its growing ecosystem of services and tools that work in conjunction with Square's core payment processing service as its competitive advantage. Indeed, customers that use multiple Square products -- for example, payment processing, Square Capital, and its payroll service -- are less likely to switch to a competing platform.

But that's not much of a competitive advantage. That knife cuts both ways. PayPal, Intuit, and Shopify all have their own unique suites of tools for merchants, and some options may fit the needs of merchants better than Square's. Square's additional services don't necessarily work to attract new customers in the first place.

The impact is seen in Square's gross margin. Square's gross margin over the trailing twelve months is 37%. Shopify and Intuit have posted gross margins of 56% and 84%, respectively, during the same period. Square takes a relatively small loss on its hardware sales, but the core operations still don't make up for the margin difference between itself and competitors.

A rapidly growing business

Despite only a small competitive advantage, Square is managing to grow rapidly. The company is investing heavily in new services and expanding its existing products to meet the needs of its customers. That helps with retention and increases revenue per merchant. It also helps stave off the growing competition, as Square has no other moat. Square is also spending heavily on marketing at it enters new markets and faces new competition.

The efforts have paid off with better-than-expected revenue growth. Management reiterated plans to manage margin expansion in an effort to grow revenue as quickly as possible over the next few years during the third-quarter earnings call. Indeed, adjusted revenue grew 45% last quarter, accelerating for the second consecutive quarter.

Analysts expect Square to grow total revenue over 30% next year, and that's a pace the company could realistically maintain over the next five years. Gross margin could also show improvement as the company shifts toward more higher-margin subscription and services revenue as it moves away from solely offering payment processing.

A look at valuation

Square is growing well and working to develop more of a moat around its business. Whether the stock is a buy will come down to what investors have to pay for it.

Here's how it stacks up with its other fintech competitors.

Data source: YCharts. 

Square is significantly more expensive than PayPal and Intuit, but it's trading at nearly half the valuation of Shopify. Considering stronger expected sales growth at Square compared to the two larger competitors (PayPal and Intuit), it should trade at somewhat of a premium. On the other hand, Square has yet to prove itself profitable on a GAAP basis, while PayPal and Intuit are very profitable.

After its recent run-up, Square is trading at a price that makes it a lot more risky for investors. Without much of a competitive advantage and its growth reliant on entering even more competitive markets, there's a lot of uncertainty surrounding the stock. Management has done an excellent job staking its claim to the market and expanding its product selection, but it's no guarantee Square will be able to maintain its momentum.

For investors willing to take on more risk, Square could present a great investment. More conservative investors interested in fintech might be better off with one of its profitable competitors.