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Up 120% in 2020, Is It Too Late to Buy Square Stock?

By Leo Sun - Aug 12, 2020 at 8:55AM

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The fintech company remains a favorite for growth investors, but is it worth over 250 times forward earnings?

Square (SQ -0.97%) stock recently soared to an all-time high after its second-quarter numbers soundly beat analysts' estimates. The fintech company's revenue surged 64% annually (70% after excluding the divestment of Caviar) to $1.92 billion, clearing the consensus forecast by $790 million. Its adjusted EBITDA dipped 7% to $97.9 million, but earnings of $0.18 per share still beat expectations by $0.23.

That earnings beat was impressive, but is Square's stock overheating after rallying 120% this year? Let's examine Square's second-quarter earnings, its outlook, and the valuation to find out.

A customer pays via a smartphone on Square Register.

Image source: Square.

A sharp decline in gross payment volume

Square's gross payment volume (GPV), or the value of all transactions across its platforms, declined 15% annually to $22.8 billion. That decline was largely attributed to the closures of small to medium-sized businesses throughout the COVID-19 crisis.

GPV from online channels, which accounted for over a quarter of the company total, surged over 50% annually, but that growth couldn't offset its loss of brick-and-mortar merchants. The decline was disappointing, since Square usually generates most of its revenue from those transaction fees, but it wasn't surprising.

An unprecedented surge in bitcoin revenue

Square's transaction-based revenue declined 12% annually to $682.6 million during the quarter. However, its bitcoin revenue surged 600% to $875.5 million and became the biggest contributor to the top line.

The company added bitcoin trading to its Cash app about two years ago. To generate a slight profit from each sale, Square buys bitcoin to fulfill an order and adds a small margin to bitcoin's market price.

Two catalysts sparked Square's explosive bitcoin growth: the Cash App's expanding base of monthly transacting customers, which hit 30 million during the quarter, and growing interest in bitcoin as an investment throughout the COVID-19 crisis. Bitcoin's price has already risen over 50% year to date to $11,275 as of this writing.

The two growth engines take over

The Cash App's total revenue rose 361% annually to $1.2 billion during the quarter. Excluding bitcoin transactions, revenue still grew 140% to $325 million, driven by direct deposits, Boost discounts, and physical Cash Card transactions.

Stacks of physical bitcoins.

Image source: Getty Images.

It also saw sequential growth in its new free stock trading services, which could pull investors away from Robinhood and other free trading platforms. The Cash App already surpassed PayPal's Venmo in cumulative downloads two years ago, according to Sensor Tower and Nomura Instinet, and it likely remains in the lead. Total payment volume on Venmo, which doesn't offer bitcoin or stock trading features yet, grew 52% year over year in PayPal's second quarter.

The Cash App's customers had stored over $1.7 billion in cash balances in their accounts by the end of the quarter, up 86% from a year earlier. It also benefited from direct deposits of CARES Act stimulus checks. Gross profit for this business was up 167% to $281 million, or just under half of the company's total gross profit. That growth offset a 7% decline in its seller ecosystem's gross profit and boosted Square's total gross profit 28% to $597 million for the quarter. Simply put, Square's Cash App and bitcoin businesses saved the day and insulated its business from the COVID-19 crisis.

A limited outlook and lofty valuation

Square didn't provide any guidance for the third quarter or full year. But during the conference call, CFO Amrita Ahuja said Square saw "impressive growth in Cash App and signs of stability in our seller ecosystem" in July with "more than 200%" annual growth in Cash App's gross profit and continued "momentum from the second quarter." Ahuja noted the Cash App saw its "highest monthly increase in net new transacting actives and an increase in new product adoption" during the third quarter, which suggests it will remain a major growth engine for Square even after its merchant-based transaction business recovers.

However, Ahuja warned that stimulus checks boosted Cash's growth during the second quarter, and management doesn't expect the app's growth to sustain its momentum if "stimulus programs are either reduced or not renewed." Despite those uncertainties, Ahuja expects Square to ramp up its ecosystem investments in the third quarter.

Those investments could temporarily throttle Square's earnings growth, but it's still sitting on $1.97 billion in cash and equivalents (boosted by a $1 billion debt offering earlier this year) and $714 million in short-term investments. That cash cushion should allow Square to comfortably expand its ecosystem to widen its moat against PayPal and other rivals.

But is it too late to buy Square stock?

Back in late June, I warned investors Square stock could be "overheating" at $100 per share. But as of this writing, it's hovering closer to $140 and trading at around 250 times forward earnings estimates. Those valuations are now definitely overheated, but investors seem willing to pay that premium for this company's long-term growth potential.

Therefore, growth-oriented investors can accumulate some shares of Square at these levels, but they should keep some powder dry in case of a pullback, which could happen soon as the market faces unresolved headwinds from COVID-19, trade, and unemployment.

Leo Sun owns shares of Square. The Motley Fool owns shares of and recommends PayPal Holdings and Square and recommends the following options: short September 2020 $70 puts on Square and long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

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