Could Square Be a Millionaire Maker Stock?

One of the best times to invest in a company is as it makes its transition from all-out growth (a young business where sales are the primary driver of stock price) to profitable growth (when the company starts reaching a more efficient scale and the bottom line starts to expand). This is the leg of the journey Square (SQ -1.00%) is beginning to find itself on.

Even though 2020 has been a difficult year for its merchant services business due to the pandemic, Square's consumer-facing Cash App is paying off in a big way. Shares are up nearly 250% so far in 2020, valuing Square at a market cap of some $94 billion. It may not be a small stock with the promise of potentially life-changing returns anymore, but it could nevertheless add some serious growth to investor portfolios over the next decade. 

Image source: Getty Images.

A solid bet on a "normalizing" economy

Historically, Square is a financial services and digital payments company servicing small- and mid-sized businesses. The economy going into lockdown back in the spring of 2020 should have been a recipe for disaster for this segment, and indeed share prices did briefly tank by more than 50% in late February and early March as worry over the health of the most vulnerable businesses in the economy mounted. 

But the stock came roaring back with a vengeance. Small companies' ability to quickly pivot to online sales was underestimated. While Square's "seller ecosystem" segment has been far from perfect, it hasn't been an unmitigated disaster either. In fact, Square itself is partly responsible for helping its customers roll with the punches and adapt to the new digital-first reality that was foisted upon them. 

YOY = year-over-year. Data source: Square.

Square's merchant-facing services returning to growth in the summer months was great news, and there's plenty of room for even further rebound here. As the economy finds its footing again, the myriad of companies leaning on these payments and financial management tools should see an uptick in activity -- and return the "seller ecosystem" to double-digit percentage expansion mode once again.

The banker of the future?

While you wait for a rally in Square's older business, there's still plenty to like about Cash App. In fact, it's this segment that's responsible for Square's overall year-over-year revenue advance of 86% through the first nine months of 2020. Adding the ability for users to trade stocks and bitcoin has been a real differentiator for the mobile wallet. Bitcoin-related revenue specifically has gone from $339 million during the first three quarters of 2019 to $2.82 billion in 2020. 

Granted, this is a very low-margin area for Square. All of that cryptocurrency revenue equated to gross profit of just $56 million so far this year. However, adding new features like the ability to hold bitcoin tokens in the same place as digital dollars has boosted the number of people making monthly use of Cash App for more than its basic peer-to-peer money movement capabilities (like the more than 2.5 million people who moved stock brokerage accounts to Cash App in Q3 2020). These customers used the app for an average of three to four transactions per month more than those only using the money transfer feature, and it generated a roughly equivalent amount in additional profit for Square. Excluding bitcoin, Cash App revenue and gross profit jumped 174% year over year in Q3 alone to $435 million.

Cash App expansion efforts eat up a lot of spare funds at Square as the company tries to maximize the number of users -- meaning both consumers and a growing number of businesses signing up to accept Cash App -- and additional services it can offer via the mobile application. But in spite of heavy spending and other disruptions caused by the pandemic, Square is already starting to achieve higher profitability. Adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) was $181 million in Q3 2020 -- an increase of 38% from the same period in 2019, and a massive rebound from just $9 million and $98 million in Q1 and Q2 2020, respectively. 

Backing out bitcoin revenue, Q3 adjusted EBITDA was good for a 13% profit margin. Not bad for a company still emphasizing growth before bottom-line returns right now. And as Square's various initiatives start to bear fruit, these returns will only get dramatically better over time. This financial technology firm is amassing all the tools necessary to go head-to-head with traditional banking institutions, but it packages its services into a far more efficient operation through users' smartphones.

In short, Square is a big business these days, but there's plenty of room for further upside as merchants and consumers continue to flock to the platform. There's a clear path to this becoming a much larger business in a decade or two than it is now. Will buying a small position make you a millionaire someday? Probably not. But it could certainly help.