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Why Is Everyone Talking About Square Stock?

By Will Healy – Updated Aug 14, 2021 at 9:34AM

Key Points

  • Both the Seller and Cash App ecosystems should experience higher activity.
  • Square is playing an increasingly crucial role in the finance industry.
  • Amid its successes, investors should take note of its valuation.

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A promising acquisition serves as a reminder of this fintech's potential.

Square's (SQ -0.84%) recent earnings announcement sent the stock surging higher in early August. This marks the latest move forward for a fintech giant that recently took an unprecedented step into traditional finance by opening its own bank. Moreover, Square continues to benefit from massive growth in its popular Cash App, and a key acquisition should bring a tremendous boost to both its Cash App and Seller ecosystems.

Barista processes a transaction at a coffee shop.

Image source: Getty Images

What drove the excitement around Square

Most of the attention around Square centers not so much on financials, but on its intention to buy Australian fintech company Afterpay (AFTP.F), a transaction that will entail purchase of all of Afterpay's stock for $29 billion. Afterpay allows Square to supercharge buy now, pay later (BNPL) payment options, making it easier for consumers to purchase products and pay in installments without interest.

Square will offer Afterpay on both its Seller and Cash App ecosystems. It will also enable merchants to promote BNPL offers within Cash App. Afterpay earns money on both merchant fees and any late fees should buyers miss payments. This probably means that Square will foster a new revenue source as it offers consumers a viable, interest-free alternative to credit cards.

Afterpay had already recruited almost 100,000 merchants globally who currently serve over 16 million customers. Now, with Cash App's current user base of more than 70 million, it could experience an exponential increase in activity.

Square's current state

More importantly, Square has become a massive finance ecosystem that has supplanted many consumer finance needs. In addition to its original app that allowed anyone to collect credit card payments, consumers can manage the collection, spending, and even brokerage services through Cash App, with Afterpay set to add one more function.

Square's ecosystem benefited from another key addition. Square already offers services for payments, financial management, capital, and payroll. Now, thanks to Square Bank, Square can provide full-service banking for businesses, giving its ecosystem full independence (within business finance) from traditional banks.

Square has already started its international push, although just barely: It has a presence in only six countries. Its latest market entry, Ireland, is its first country that uses the euro. And now that Square has entered the EU, it could experience a more rapid entry into the remaining 18 countries that utilize the currency.

Square's financials

The Afterpay news overshadowed Square's second-quarter earnings, which show the company remains in a rapid growth mode. Due to accounting regulations, Square must log Bitcoin payment volumes as "revenue," so Bitcoin accounted for $6.2 billion of Square's $9.7 billion in revenue during the first six months of 2021. However, even when factoring out the effects of Bitcoin, revenue surged 69% versus the first two quarters of 2020.

Since operating expenses grew by only 53% during that period, Square reported a net income of $243 million. This is a tremendous improvement from its $117 million loss in the first six months of 2020.

Nonetheless, Square expressed caution on its immediate future and did not publish 2021 projections. It forecasts year-over-year gross profit growth for Cash App of 212% in the third quarter compared with Q3 2020. Still, for the Seller ecosystem, it only expects a 12% gross profit increase due to continued restrictions on in-person activity in some regions.

It also faces some potential valuation concerns. These go beyond the 95% increase in the stock price over the last 12 months or the flirtation with Square's all-time high of $289 per share.

SQ Chart

SQ data by YCharts

Its price-to-earnings (P/E) ratio of around 235 is substantially higher than pre-pandemic levels, when the earnings multiple stood at around 100. It also comes in well above competitor PayPal's P/E ratio of approximately 67.

Additionally, its price-to-sales (P/S) ratio of nine may seem in line with historical averages. However, analysts measured it against the stated Q2 revenue level of $4.7 billion, which includes Bitcoin trading volume.

When subtracting Bitcoin payment volumes, Bitcoin revenue amounted to only around $55 million out of Square's $1.9 billion in real revenue in Q2. This means the actual P/S ratio comes in at approximately 22, about 2.5 times higher than the stated sales multiple and well above historical averages.

More importantly, these numbers dramatically overstate the importance of Bitcoin to Square. Bitcoin accounts for less than 3% of Square's real revenue instead of the 58% implied by the stated figures. If investors bought Square due to the stated Bitcoin revenue numbers, it might negatively affect Square stock in the short term if the company stopped logging payment volumes as revenue.

Investor takeaways

The Afterpay acquisition is a reminder of Square's potential. It adds an attractive component to a financial ecosystem that already marries traditional finance with fintech. I think that Square is changing the face of consumer and business finance as we know it.

Given the increases in Square stock and its heightened valuation, the market appears to recognize this potential. While that stock price surge could bring uncertainty to where Square will go in the short term, it is a fintech stock worth considering, especially if a correction occurs.

Will Healy owns shares of Square. The Motley Fool owns shares of and recommends AFTERPAY T FPO, PayPal Holdings, and Square. The Motley Fool recommends the following options: long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

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