Square (NYSE:SQ) has been one of the best-performing stocks through one of the worst economic periods in decades. Its stock price is up a whopping 199% year to date in a market where the S&P 500 is up approximately 7%. To say that the mobile payment specialist has surfed this year's tech wave would be selling it short.
There are a few good reasons why Square has performed so well. Its innovative products and its status at the forefront of the accelerating cashless trend have helped, as has its strategic position serving buyers and sellers alike. And the pandemic has definitely contributed to the stock's surge, as shutdowns and social distancing protocols have made mobile payments more essential than ever.
The stock has risen so high, so fast in a fragile economy that investors may be wondering if its valuation -- a ridiculously high price-to-earnings ratio of 292 -- is sustainable.
It's a good question. To answer that, let's look out a year from now to project where Square will stand and what challenges and opportunities it will face.
Square expands into banking
The big change for Square on the immediate horizon is the debut of the Square bank. The company got approval from the Federal Deposit Insurance Corp. (FDIC) earlier this year for an industrial loan company (ILC) bank charter. The bank, which will be operated by Square Financial Services, will be based in Utah and be supervised by both the FDIC and the Utah Department of Financial Institutions. It is slated to open sometime in 2021.
This has a chance to be a game-changer for Square, as it would allow it to connect its ecosystems of buyers and sellers. Currently, Square serves both groups. It serves sellers, or merchants, by providing the mobile technology that allows them to process payments, conduct payroll, and perform other functions. It serves buyers, or consumers, by allowing them to send and receive money through its mobile Cash App and accompanying Cash Card.
The bank's primary focus will be on offering small-business loans as well as deposit products. For small businesses, Square would provide a one-stop shop for banking, payroll, loans, and other services, while offering direct deposit through the Cash App. And with less overhead, it would likely be able to charge lower fees, providing an advantage over most competitors. This would allow the company to tie together those two ecosystems, which CEO Jack Dorsey has said is a goal, as there "is a lot of real strength that comes from connecting the two ecosystems."
Square has made other moves within the last few months to connect the ecosystems with products like On-Demand Pay, which allows payroll customers' employees to take a cash advance of up to $200 from their earnings at any time through the Cash App. Also, its Instant Payments service enables payroll customers to instantly fund their payrolls with money in their balance in their Square account. These initiatives will all enable Square to expand their utility for customers, which should lead to an expansion of profits.
Killer cash app
The cash cow for Square has been the Cash App. In the second quarter, the Cash App, which is a mobile app that allows people to send and receive money, had $1.2 billion in revenue and $281 million in profit. It generated 62% of the company's revenue in the quarter and 47% of its profits.
In the second quarter, earnings for the CashApp were up 167% year over year with about 30 million active users -- up 6 million from the previous year. In just two years, dating back to the second quarter of 2018, the Cash App has seen a 639% increase in profits.
Along with PayPal's Venmo, it is the most popular app, but it has been growing in recent years at a faster pace than Venmo.
With the pandemic only accelerating the cashless trend, there are no signs of the Cash App slowing down. Within the next 10 years, some developing nations will be entirely cashless and within the next 20 years cashless will be king in many nations around the world. Square should be at the vanguard of that movement.
While the stock has a high valuation, it also has incredible earnings power. Short term, there could be some backlash if (and some say when) the tech bubble bursts. But long term, Square is a fantastic stock.