Square (NYSE:SQ) started off as a simple way for artisans and street vendors to accept credit cards, and now it's one of the biggest financial technology companies in the world. It's expanded from helping small businesses process credit cards to developing a whole host of services for merchants both large and small. It also offers consumer-facing services through Cash App (formerly Square Cash), including offering a deposit account and bitcoin trading.

Square's business is constantly changing as it expands its ecosystem of services. Taking a look at the history of the company and its stock can be enlightening for investors.

Square's mobile credit card reader attached to an iPhone.

Image source: Square.

The early days

Jack Dorsey co-founded Square with fellow St. Louisan Jim McKelvey in 2009 after stepping down as Twitter (NYSE:TWTR) CEO in late 2008. The idea behind Square was to make a credit card reader that transmitted data via the headphone jack in increasingly popular smartphones.

In order to get the idea off the ground, Dorsey and McKelvey needed to raise funds from venture capitalists -- investors willing to put their money on high-risk, high-reward start-ups. The two would sell a share of the company to investors in exchange for capital to run the business. The percentage of the company sold and the amount the founders received is based on how much the investors think the company is worth -- in other words, its valuation.

Dorsey and McKelvey raised their first round of funding in November of that year, with Series A totaling $10 million with the company at a valuation of $30 million. Early investors include Twitter co-founder Biz Stone, former Yahoo! CEO Marissa Mayer, and Napster founder Shawn Fanning.

With the $10 million in funding, Square developed its first product -- the white square-shaped credit card reader that inspired the company name. It launched its official website (squareup.com) the next month, and it opened its product pilot test to 50,000 people. Those readers shipped in May of 2010, at the same time Square launched its app in the iOS and Android app stores.

By November, a year after its initial fundraising round, Square was processing millions of dollars in gross payment volume every week. Gross payment volume is a metric Square uses to describe the amount of money its merchants process using its card readers. In order to expand the Square reader to the public, the company raised a second round of funding -- $27.5 million with the company at a valuation of $230 million -- in January of 2011. Visa bought a small stake in the company during that round.

After opening the card reader to the public, Jack Dorsey announced Square was processing $1 million in gross payment volume per day in March. Gross payment volume climbed to $2 million per day in April, and $3 million per day in May.

Square developed an iPad app to replace cash registers aptly called Square Register. On top of that, Square struck a deal with Apple to sell its devices in Apple stores, increasing the visibility of its product and winning a huge endorsement from the smartphone market leader.

Capitalizing on its rapid growth, Square raised another round of capital, taking in $100 million when the company was at a valuation of $1 billion. Over the next year, it grew to an annual run rate of $8 billion in gross payment volume.

In the summer of 2012, Square struck a deal with Starbucks. In exchange for a $25 million investment, Square would become the credit card processor for the coffee chain. Square would end up losing a lot of money on the deal, but it gave Square a lot of notoriety and the experience needed to offer services to large merchants with multiple locations. The Starbucks deal was part of Square's Series D funding round, which totaled $200 million with the company at a valuation of $3.25 billion.

Over the next year, Square developed several new products, including the Square Stand (which turns an iPad into a complete point-of-sale system), the Square Cash app, and Square Market (a tool to create online storefronts). By October of 2013, Square had 600 employees working on various parts of the business, double the amount it had a year prior.

Square continued to pump out new products in 2014. It launched Square Order, which allowed customers to order food from nearby restaurants and pay for it within the app. Three months later, it would acquire Caviar, a food-delivery start-up, and fold Square Order into the acquired app.

In the interim, Square launched one of its most successful services, Square Capital. Square Capital uses data from merchant sales to make small cash advance loans to businesses using Square's credit card processor. Merchants pay back the loan with each credit card swipe.

That led to Square's final private funding round: $150 million with the company at a valuation of $6 billion.

A timeline of Square's pre-IPO funding

Round

Date

Funds Raised

Valuation

Series A

November 2009

$10 million

$30 million

Series B

January 2011

$27.5 million

$230 million

Series C

June 2011

$100 million

$1 billion

Series D

September 2012

$200 million

$3.25 billion

Series E

October 2014

$150 million

$6 billion

Data source: fundingpath.co.

Early competition

Intuit launched a mobile point-of-sale system, GoPayment, before Square brought its first product to market. The original GoPayment product launched in 2009 used a Bluetooth connected card reader to transmit data to a smartphone. Merchants could also input card information manually.

Intuit eventually integrated GoPayment with its point-of-sale software, QuickBooks POS. That move allowed merchants to easily sync inventory and financial data and manage multiple locations, providing an overview of a merchant's business. Square would later adopt some of those same features as it expanded to larger merchants, and it found that they were equally valuable for small businesses.

PayPal launched PayPal Here in March of 2012. PayPal undercut Square's pricing by 5 basis points (or 0.05 percentage points); it also undercut the number of sides on its card reader by one. The online payments leader tried to differentiate its product by offering remote check processing and a business debit card linked to merchants' PayPal accounts. The latter gave businesses faster access to their funds, a service that would eventually prove lucrative for both PayPal and Square.

Shopify launched an in-store credit card reader designed for the iPad in 2013. The system echoed many of the features of Square and its earlier competitors, including tracking sales, customers, and inventory, and providing customers with emailed receipts. Shopify also enabled its online merchants to easily manage their business across channels -- online and in stores.

Amazon entered the market in 2014. Amazon Register looked to undercut the pricing of services like Square and PayPal Here in order to take market share. Merchants could pay just 1.75% of gross payment volume to process transactions for their first year or so with Amazon Register. The price would climb to 2.5% after the promotional period ended, still undercutting the competition. That compared to 2.75% for Square and 2.7% for PayPal Here and Intuit's GoPayment. At that price, Amazon was taking a significant loss on the product.

Amazon seemed more interested in gleaning data from small businesses than it was in turning a profit directly from payment processing. Merchants weren't falling for the trojan horse strategy, though, and Amazon shut down Amazon Register within a year and a half.

Square faced a considerable number of other copycat products, but none have managed to capture the market quite like Square despite many having an established presence in financial technology and existing relationships with merchants. Square benefits from its elegant hardware and software design, its market-leading speed of transactions, and its growing portfolio of ancillary services that complement its card readers.

Leading up to an IPO

In June of 2015, Jack Dorsey was named interim CEO of Twitter, the company he left in 2008. At the same time, he was preparing to offer Square stock to the public for the first time, working on filing the necessary paperwork with the Securities and Exchange Commission to make an initial public offering, or IPO.

Dorsey was suddenly in charge of two companies -- one preparing for an IPO, and the other struggling to turn things around after several quarters of disappointing user growth and financial results. Many called into question whether Dorsey could manage both companies at the same time, and they expected Twitter to find a different permanent replacement for former CEO Dick Costolo.

In October, Twitter named Dorsey its permanent CEO. Square filed its S-1 Registration Statement with the SEC later that month, declaring its intentions to go public.

The S-1 revealed that Square processed nearly $24 billion in gross payment volume in 2014, and nearly $16 billion through the first six months of 2015.

The filing also revealed just how much Square was losing in its partnership with Starbucks, breaking out the details of the Starbucks business in its income statement. Square generated $123 million in transaction revenue from Starbucks in 2014, but the costs to process those transactions reached $151 million. The company noted that it amended its agreement with Starbucks to start charging it more to process transactions effective October 1, 2015, and it expected Starbucks to switch payments processors in the third quarter of 2016. (It did.)

Square priced its stock at $9 per share in November, valuing the company at just $2.9 billion, about half of its valuation in its last private funding round, which took place about a year prior. Due to language in that funding round, Square issued Series E investors additional shares to ensure they didn't take a loss when Square made its IPO. That diluted the shares of earlier investors as well as those of Square employees, who received considerable stock-based compensation.

A person using contactless mobile payment to pay at a Square Register.

Image source: Square.

Off to a rocky start

Like many highly anticipated IPOs, Square saw a nice pop when it initially started trading on the public market. Shares climbed to nearly $15 when it made its debut on November 19, 2015, settling at just over $13. That didn't last long, though, and shares dipped below the IPO price by the end of January.

Square shares climbed from their February lows, boosted by strong fourth-quarter results. But the company disappointed investors with its first-quarter 2016 results, beating revenue expectations but falling short on net profit and sending shares back down to their IPO price.

The first nine months or so of Square as a public company proved extremely frustrating and disappointing for investors.

SQ Chart
Square's disappointing stock performance through 2016.

However, Square started to turn things around in the second half of 2016. It ended the year with $50 billion in gross payment volume (excluding Starbucks), up 39% year over year. Services launched in 2014 or later, like Square Capital and Instant Deposit, accounted for 25% of adjusted revenue for the year. Those services hold potential for much higher profits and are key to Square retaining merchants among a competitive landscape.

Square produced positive adjusted EBITDA in each of the last three quarters of 2016. EBITDA -- which stands for earnings before interest, tax, depreciation, and amortization -- is a measure of a company's profitability when financing and accounting decisions and taxes are excluded. It's effectively operating profit with non-cash expenses like depreciation and amortization added back in.

Square also produced strong profit-margin expansion during those quarters, including a 16% EBITDA margin in the fourth quarter. (Margin is the percentage of revenue kept as earnings.) Strong fourth-quarter results helped Square stock climb above $17 per share in February 2017.

Rapid expansion in 2017

2017 was an excellent year for Square and its shareholders. CFO Sarah Friar guided for mid-single-digit EBITDA expansion for the year, and the company exceeded that rate through the first three quarters of the year. Friar would later note that level of margin expansion was more of a failure to find and pursue good investment opportunities, but investors loved it in the meantime. Square posted a decline in adjusted EBITDA margin in the fourth quarter, indicating a resurgence in investment activity.

That's not to say Square didn't invest heavily in 2017. Square expanded its service to the U.K. in April, its first European market. The U.K. presents an excellent market opportunity for Square, as 99% of private-sector businesses are considered small businesses. Moreover, a large percentage of merchants are still cash-only.

Square also invested a lot in financial services. Square Capital grew to over $1.25 billion in loan originations for the year, although originations were generally flat from quarter to quarter in the latter part of the year. Square started partnering with other companies to expand Square Capital to small businesses that don't use Square's point-of-sale platform in an effort to continue growing originations. It also applied for a bank license in order to increase its take on those loans, but it later withdrew its application, tabling those plans.

Square also made moves to push users to take multiple products in order to increase retention and profitability. Products launched since 2014, including Square Capital, Caviar, Invoices, Instant Deposit, and Build with Square APIs accounted for 36% of adjusted revenue by the fourth quarter.

Meanwhile, Square built out the functionality of Cash App, which it rebranded from Square Cash in 2017. It added a virtual debit card at the end of 2016 and found enough traction with the product to launch a physical debit card linked to users' Cash App balances in mid-2017. Cash App users spent over $90 million in December, an annual run rate of $1 billion.

Square also introduced bitcoin trading in the Cash App in November, launching the service to everyone in January. The introduction propelled Cash App to 7 million monthly active users by the end of the year.

All of the investments led to strong revenue growth. In fact, Square accelerated its adjusted revenue growth in each quarter starting from 39% year-over-year growth in the first quarter to 47% growth in the fourth quarter.

SQ Chart
Square's phenomenal growth in 2017.

The market really liked what it saw from Square -- accelerating revenue and a rapidly expanding profit margin -- leading to a 150% increase in the share price over the course of the year.

2018 and the future

Square continued its strong growth in 2018. Adjusted revenue continued its acceleration through the first two quarters of the year, reaching 60% year-over-year growth in the second quarter. Despite beating Wall Street analysts' expectations and her own guidance for revenue growth, Friar isn't increasing the company's guidance for EBITDA. Despite the announcement that Sarah Friar would be departing Square soon, she did note that she'd rather produce an absolute amount of earnings than focus on margins in order to show investors earnings growth.

Friar and Jack Dorsey outlined three main areas of focus at the beginning of the year: expanding Square's omnichannel offerings, offering more financial services, and increasing the company's presence in its international markets.

Square continues to make progress on all three fronts.

Omnichannel services such as appointments and Caviar have grown quickly. Revenue from the food-delivery business doubled in the second quarter. Square acquired Weebly earlier this year, which helps people create an online presence. The website creation tool will enable a more cohesive approach to omnichannel, and Weebly's established international user base could give Square a foot in the door with merchants in new markets.

The company continues to work on its financial services, particularly on the consumer side. It's steadily pushed the Cash Card into more consumers' wallets, and users are spending at a $3 billion annual run rate as of the end of June. The company called out the interchange fees it collects from Cash Card usage as a key driver of its subscription and services revenue during its second-quarter earnings call. Additionally, Cash App users in New York gained access to bitcoin trading after Square acquired a virtual currency license from the state's Department of Financial Services in June.

Internationally, Square is making good progress. It finally came to an agreement with Interac in Canada to accept debit payments. The company has been working to inform existing and potential merchants about the new agreement. Square says Interac accounts for about half of card payments in Canada. Meanwhile, it's attacking the U.K. town by town, moving cash-only stores to accept card payments. The investment in marketing has proven successful, and it's even more important now that PayPal has moved into the market with its acquisition of iZettle.

SQ ChartShares kept climbing through the first nine months of 2018.

The strong growth of Square's revenue while showing strong absolute growth in EBTIDA led Square shares to climb another 150% in the first nine months of 2018.

The company is showing strong momentum in all three areas of focus for the year, and its ability to invest its excess cash and produce stable earnings is impressive. A lot of that is owed to Friar's ability to manage the company's growth and investments. Unfortunately, Friar is moving on to become the CEO of social network Nextdoor, leaving Dorsey and company to find a suitable replacement. She's staying on board until a replacement is found.

Square is creating vertical-specific software for merchants just as it has done for retailers and restaurants. It's also exploring a potential advertising product linked to its Cash Card loyalty program, Boosts. The Cash Card could also be used to offer consumer loans using data in a similar manner as Square Capital's business loans. As Square expands its ecosystem of services, its products become both more attractive and stickier, which should enable it to keep producing strong growth on both the top line and its earnings.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Amazon, Apple, and Starbucks. The Motley Fool owns shares of and recommends Amazon, Apple, Intuit, PayPal Holdings, Shopify, Square, Starbucks, and Twitter. The Motley Fool owns shares of Visa and has the following options: long January 2020 $150 calls on Apple, short January 2020 $155 calls on Apple, and short January 2019 $80 calls on Square. The Motley Fool has a disclosure policy.