It's really hard to know what will happen with a company's stock from day to day, let alone what will happen next week. But the longer you extend out your time horizon, the easier it can be to discern a company's trajectory based on their past performance and their management plans.
With that in mind, it has become a bit clearer that Trex (TREX -1.06%), Square (SQ -1.63%), and Roku (ROKU -0.67%) are three companies poised for huge stock growth over the next decade, even though all will manage to do it for very different reasons. Let's take a closer look at the three to better understand why.
1. Trex will better compete with pressure-treated lumber
Trex is a composite decking company. It manufactures planks out of recycled materials like sawdust and plastic, creating a product used in decks that has advantages over the more typical pressure-treated wood. It's both more durable and requires less maintenance.
One thing it's not is cheap. The high cost of a Trex deck can be a hindrance to some consumers and that has limited its adoption. Despite its superiority, Trex's management estimates that composite decking only accounts for about 19% of the total addressable deck market.
If Trex could lower the price of composite decking closer to that of pressure-treated lumber, it would likely gain a wider market share. And its new product, Trex Enhance, does exactly that. In its fourth-quarter earnings call, CEO James Cline said that with this cheaper product, Trex can compete on pricing in about 60% of the overall deck market -- essentially tripling the company's potential.
Management now expects increased demand with sustainable growth for at least 10 years. To meet this demand, it's spending to increase its production capacity by 70%, which is a current drag on earnings. Diluted earnings per share only grew 8% in 2019 instead of the typical double-digit growth management targets. Still, the spending is merited if it translates to a decade more of earnings growth.
2. Square is the total financial services package
Square is a fintech company that operates two distinct digital segments: Seller services and Cash App. The Seller platform provides various financial services to businesses of all sizes, while its Cash App does the same for individuals. Both are frequently referred to as "ecosystems," acknowledging the complementary features Square continually adds.
On the business side, Square starts by offering companies point-of-sale hardware at a loss. It's willing to lose money on the hardware in order to generate revenue on transactions, software subscriptions, and by originating business loans. By offering a variety of features, Square is a compelling service for small businesses.
Unfortunately, at the moment many of Square's small business clients are currently challenged due to the COVID-19 economic shutdown. In the next two months alone, 3.5 million small businesses could close permanently if revenue doesn't return, according to a recent survey by Main Street America. The profound impact of the coronavirus on small businesses is directly affecting Square and caused it to withdraw its guidance for 2020.
Fortunately, Square has other revenue streams to mitigate the struggle in Seller services. With Cash App, an individual's phone essential becomes a mobile bank. By offering direct deposit, the Cash Card for debit, brokerage services, and more, Square is a great way to invest in the war on cash. Cash App adoption has been strong. As of December, there were 24 million monthly active users, up 60% year over year. And this growth has come with minimal operational costs to Square. Cash App users wishing to transfer money to friends become advocates for the app and boost adoption.
Finally, Square's revenue is increasingly subscription-based. In 2019, subscription and services-based revenue grew 74% year over year to $1 billion, accounting for 22% of total net revenue. What's great about this revenue is that it's highly profitable. Gross profit margin for subscription and services is 77%, compared to just 37% gross profit margin for transaction-based revenue.
High growth with Square's most profitable revenue stream is a recipe for long-term success, even if the next couple of quarters are likely to be challenging.
3. Roku will run the TV of the future
One World: Together At Home isn't just the name of the simulcast coronavirus-related television special Roku users streamed on April 18, it also might be a good summary of Roku's business plan. When we're home, we kick back and watch TV. And viewing is increasingly shifting toward streaming at the expense of traditional cable TV. Roku is leading the revolution, and it wishes to be a global company.
Roku provided preliminary results to the upcoming first-quarter earnings release, and to no one's surprise, viewership was up a lot due to the COVID-19 pandemic. The company said 40 million accounts streamed 13.2 billion hours of content in Q1 -- 49% year-over-year streaming growth. But according to CFO Steve Louden, the "vast majority" of accounts are still based in the U.S.
Even with the remaining growth opportunity at home, the implication is that Roku's greatest opportunity is abroad -- and it recently expanded into the U.K, Germany, Mexico, and Brazil. But that's still just the tip of the world's iceberg. Over time, it wouldn't be surprising to see Roku enjoy the same level of adoption overseas as it has domestically. No wonder the company is calling the next 10 years the "streaming decade."
Some may wonder how Roku can be a primary beneficiary of streaming TV when bigger competitors like Amazon offer similar services. Roku is doing a better job becoming a widespread operating system on a number of smart TVs -- TVs that connect to the internet without special hardware. Fire TV from Amazon runs a limited number of TVs. Roku, by contrast, has partnered with dozens of brands globally. With more options, it's very likely that consumers looking for a new smart TV will choose to establish a relationship with Roku.