Considering the ferocity of the global market sell-off due to the coronavirus, shareholders of Square (SQ 3.97%) ought to feel quite pleased at the moment. While the S&P 500 is down 3% year to date, shares of the digital payments company are up 27% as of this writing.
However, Square is still down about 20% from the all-time highs it reached over the summer of 2018 and has been stuck in sideways movement ever since. Admittedly, it sometimes takes years for stocks' prices to correct themselves. But with business growing by double-digits over that span of time and set to continue their momentum in 2020, this financial technology outfit is beginning to look like a value stock.
Two platforms addressing businesses and consumers
Excluding effects from the divestiture of its Caviar food delivery business last summer, Square's fourth-quarter 2019 revenue and adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) both increased 46% year over year. Full-year sales were $4.71 billion, up 43% (or 45% excluding Caviar), and 2019 adjusted EBITDA was up 63% to $417 million.
After offloading Caviar to DoorDash (which yielded Square a cool $373 million gain on its investment), Square's business can be broken down into two segments: the seller ecosystem and Cash App. The seller ecosystem generated $3.46 billion in 2019, a 27% increase year over year. Square's services continued to gain traction with small- and mid-size businesses, with the value of all payments processed gaining 25%, and other offerings like Square Capital (which originates business loans) and other software subscriptions giving the seller ecosystem a boost.
The much smaller Cash App segment generated $1.11 billion in total revenue, up 157% year over year. The peer-to-peer money transfer app grew monthly active accounts to 24 million, compared with 15 million at the end of 2018. Annualized revenue per user has more than doubled in the last two years to more than $30 (excluding Bitcoin-related revenue) as of Dec. 2019. Most of that revenue has come from more users transferring money, but management also credited the Cash Card debit card and rewards that link to a user's in-app balance as keys to the increase. Cash App users are also discovering ancillary services like the ability to purchase Bitcoin and place stock trades (including fractional shares) through the company's mobile software. Put simply, this fast-growing segment is only just beginning to generate revenue and has plenty of room to keep growing in the years ahead.
A growth-at-a-value investment
But why buy this war-on-cash stock now? As I mentioned earlier, Square's top line has more than doubled over the last two years, and shares have been caught in a volatile ride with little long-term change since prices last peaked in the summer of 2018. While the company currently generates little in the way of profit as it invests heavily to maximize its growth, the stagnant trading -- while business continues to grow -- has resulted in a reasonable-looking valuation.
As of this writing, Square trades for just 7.3 times trailing 12-month sales and 5.8 times management's projected 2020 revenue ($5.93 billion at the middle of the range). That compares with PayPal (PYPL 2.23%), whose Venmo app Cash App competes with, trading for 7.6 times trailing 12-month sales and 6.4 times projected 2020 revenue. For reference, Paypal's 2019 revenue grew 15% and is expected to increase 17% to 18% in 2020, although PayPal recently updated its outlook and said first-quarter revenue could be reduced by 1% due to the impact of the coronavirus.
What that equates to is a relative value for the faster-growing Square, even though the larger Paypal's gross profit margin was some 4.8 percentage points higher in 2019. Generating bottom-line returns isn't the main focus right now at Square, but the potential is nonetheless there as its seller and consumer ecosystems expand and become more efficient. Free cash flow (what's left after cash operating and capital expenses are paid) was $403 million in 2019, a 300% increase from two years ago.
Put simply, Square is a fast-growing fintech company, but it's trading at value pricing given its momentum and future potential. After the fourth-quarter 2019 report, this is one of the top stocks on my 2020 buy list.