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Up 253% in 2020, Is Square Still a Buy?

By Dave Kovaleski - Dec 31, 2020 at 6:00AM

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Square has had a phenomenal year, but can it continue to soar?

Square ( SQ 0.37% ) has had as good a year as any in the financial sector. The digital payments company broke out in 2020, with its stock up 253% as we enter the last trading day of the year.

As investors think about their portfolios heading into 2021, they might be kicking themselves if they missed out on that growth. But they also may be wary of jumping in now, given how high and how fast the stock has soared. Have they missed out, or does Square still have further to fly?

Can you spare a Square?

The first question cautious investors will have about Square is: Is its run-up related primarily to the circumstances surrounding the pandemic, or is there more there? The answer is yes on both counts.

A woman, deep in thought, with her left hand on her chin.

Image source: Getty Images.

Square has certainly seen its stock price spike this year due to the pandemic. The services that Square provides -- particularly its Cash App, which allows people to send and receive money without physical contact -- have become more necessary during these times of social distancing and working from home. The numbers bear this out. 

The company released a survey in September that showed a rise in the number of its seller or merchant clients that are going almost entirely cashless. In February, before the pandemic, 5.4% of its sellers were mostly (95% or higher) cashless. That number hit 13.4% in August, after spiking to 23% in April. Also, the percentage of cash transactions among its business clients fell to 33% in August from 40% the previous August -- a precipitous decline that Square officials expected three years to achieve.

As mentioned, the Cash App has been a cash cow, generating $2.1 billion in revenue in the third quarter, which accounts for about 70% of overall revenue. Revenue for the Cash App was up a whopping 574% year over year in the third quarter. The meteoric growth has led to high multiples, as the price-to-earnings ratio is a ridiculously high 340 and the price-to-sales ratio is an equally inflated 14. So, with these metrics, is Square poised for a snapback in 2021?

Higher to fly

It is doubtful that Square's stock price will repeat the type of growth it saw in 2020, but, that said, this is a company that's poised to continuing growing in 2021 and for many years to come.

First, the Cash App will only continue to grow. While the pandemic may have accelerated its growth, it was already on an upward trajectory. The trend toward cashless payments is not going away; in fact, it should continue to rise as economies throughout the world gradually move away from cash over the next decade -- and beyond. As the market leader (along with PayPal's Venmo), the Cash App will benefit from that trend. Ultimately, the Cash App serves as a sort of bank for its buyer's ecosystem, as users can accept direct deposits, make payments, even invest in stocks.

While the multiples are high, the growth expectations for Square are sustainable because of the Cash App and because the company should see a bounce back within its seller's ecosystem. Revenue from this side of the business had always been higher than the buyers/Cash App side up until this year. In the third quarter of 2019, for example, the Cash App accounted for 24% of revenue, while the seller side -- meaning its merchants services like Square Payroll, Square Register, and other services for sellers -- generated 72% of total revenue.

Revenue was down in 2020 due to the pandemic as merchants were hurt by shutdowns and social distancing. But as vaccines roll out in 2021, Square's seller ecosystem should see revenue climb back up. Plus, Square received an industrial loan company (ILC) bank charter and expects to launch a bank in 2021 to provide loans to its sellers. This will boost its value to its merchant clients, providing them with a one-stop shop, and should allow them to grow this segment of their business.

So, while Square may seem some short-term volatility in the new year, this fintech is transforming the banking and payments industries. It should be a great investment for a long time to come.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Square, Inc. Stock Quote
Square, Inc.
$212.87 (0.37%) $0.79
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
$187.24 (-0.29%) $0.55

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