Square (SQ 3.19%) recently announced on Twitter its plans to roll out commission-free stock trading through its person-to-person payment app, Cash App. This pits the San Francisco-based company squarely in competition with the granddaddy of free stock trading, Robinhood, in addition to all the other brokers recently introducing free trades. Square and Robinhood both target younger users, but unlike Robinhood, the Cash App plans to allow fractional stock sales, so investing $1 in a stock that sells for $300 a share is an option.
But the offering is more than just another nifty feature. Square is working to shed its historical image of serving businesses and gain broader appeal. Square is targeting those who are new to investing and this is a smart move. One study shows three out of five millennials lack exposure to the stock market, leaving a large market for Square's novice-friendly approach.
Offsetting declining growth rates
Should the new stock trading offering succeed and bring more folks to the Cash App -- which had 15 million users at the end of 2018 and "has continued to grow since then," according to the company -- it might offset declining growth in the amount of payments flowing through Square's platform.
Whereas Q2 2018 recorded 30% YoY growth in payments processed, that number has steadily declined by about one percentage point each quarter thereafter. For the second quarter this fiscal year, the company clocked a 25% YoY growth rate, with $26.8 billion moved through its processors.
Although its payment volume growth sank, there was good news. In Q2 this year, the company nearly turned a profit by clocking in a net loss of only $7 million, a significant improvement from double-digit losses in the prior two quarters. Additionally, EBITDA registered at $105 million, making Q2 one of the best quarters in quite a while.
So how might freebie stock trades help the decade-old company?
Turning a buck on stock sales
While it's not yet clear how Square plans to make money off the new stock trading initiative, two strategies are possibly at play: bringing home the bacon by selling customer "order flow," or continuing the deeper success Square has enjoyed from integrating bitcoin in Cash App.
Selling order flow is a way many brokerages, including Robinhood, pull in revenue. Simply put, when a person places an order to buy or sell stock, it is routed to a third-party company, known as a "market maker," which links buyers and sellers. Often, market makers are willing to bid for the opportunity to handle someone's order. The motives for this are varied, but it could be because the market maker needs better supply, or liquidity, for certain stocks, or the market maker wants to temporarily hold the shares to resell at a later time for a profit.
The amount of dough that can be scooped up through selling order flow is significant. In 2018, Robinhood took in $69 million in order flow payments, while Schwab pulled in $139 million and E*Trade bagged $174 million, according to research firm Alphacution.
While selling order flow is one strategy to monetize Square's stock trading offering, it's chump change compared to the longer-term benefits the initiative could provide.
In Cash App's early days, revenue was as scarce as water in the Saharan desert, pulling in a paltry $1 million in 2016. Fast-forward three years and Cash App raked in $260 million in net revenue during Q2 this year. Nearly half of that was from bitcoin transactions, with $125 million in bitcoin revenue equaling over 10% of Square's $1.17 billion in total revenue.
Although the company's bitcoin financials may be juicy, the cryptocurrency's deeper value to the company is its ability to lure everyday folks, particularly millennials and Gen Z, to use the app. The hope, according to CEO Jack Dorsey, is to eventually see bitcoin gain mainstream adoption and regularly be used for making payments, such as with Square merchants.
In a July tweet, Square's head of crypto, Steve Lee, responded to a question about whether Square merchants would be able to integrate bitcoin payment by saying Square Crypto is "focused on open-source Bitcoin development. We do hope our work improves as many products and businesses as possible, including Square and its competitors."
Square has further evidenced a mass-appeal priority by tricking out its Cash App website with illustrated beginner tutorials explaining bitcoin and, more recently, stock investing and trading.
As the company grapples with declining revenue growth rates, Square is pivoting away from its historical business-focused image by bringing everyday consumers onboard for the long term. When the company reports Q3 earnings on Nov. 6, investors should look for guidance regarding how the company will use its stock trading feature to lure in customers for (hopefully) life.