Square Stock Is an Undervalued Winner That Absolutely Is Worth a Look

Square (NYSE:SQ) has had an OK 2019, but Square stock isn’t really performing like the star it is.

Square Stock sq stock

In 2018, I coined the acronym STARS. It was my version of the modern FANG acronym, and stood for the five stocks which I felt were redefining the future, and in so doing, would produce huge long-term gains for investors.

The 5 STARS stocks are ecommerce solutions provider Shopify (NYSE:SHOP), programmatic advertising leader The Trade Desk (NASDAQ:TTD), visual cloud giant Adobe (NASDAQ:ADBE), streaming service enabler Roku (NASDAQ:ROKU), and payments processor Square.

In 2019, the STARS stocks have been on fire, with one exception: Square stock. While the average year-to-date gain across the other 4 STARS stocks is north of 80%, SQ stock is up just 15% in 2019. That is roughly in-line with the 14% year-to-date gain for the S&P 500, so Square isn’t really even a market out-performer this year.

Square Stock Is Still a Star

Despite the underperformance relative to its STARS peers in 2019, I’m not throwing in the towel on Square. Instead, I’m doubling down on the stock.

Given its strong innovation pipeline, healthy leadership position, robust growth trajectory, secular growth tailwinds, and relatively small penetration rate in a huge global retail market, Square absolutely deserves its place in the hyper-growth STARS acronym. This company (and stock) are oozing with long term growth potential.

The market is simply taking a cautious approach to SQ stock in 2019. Why? Growth is slowing and competition is ramping. But, growth won’t slow forever, and competition concerns will eventually fade with scale. These headwinds will eventually reverse course. When they do, they will be replaced by more permanent secular tailwinds that will ultimately power Square stock significantly higher.

Consequently, ephemeral headwinds are creating “buyable” weakness in Square stock. That’s why I’m optimistic on shares of SQ here.

Near Term Headwinds Won’t Last

The bear thesis on SQ stock is pretty simple. It goes something like this:

This is a payments processor that has already had its day in the sun. The company successfully built a payments processing empire in the micro-merchant world. Now, that world is saturated with Square solutions. Square needs to grow outside of its core base. Consequently, they are branching into the bigger merchant world.

But, that world is flooded with competitors, like First Data (NYSE:FDC), PayPal (NASDAQ:PYPL), Shopify, and big banks. Thus, as Square has expanded into the bigger merchant world, the company has more frequently rubbed elbows with the competition, and growth has slowed.

This slowing growth trend will persist, ultimately implying that today’s valuation underlying SQ stock (12-times forward sales) is too rich.

But, this thesis lacks scope and is unnecessarily shortsighted.

Sure, Square’s growth rates are slowing. But, not by much, and any slowdown can be attributed to the fact that Square is expanding into new markets. When you expand into new markets, especially competitive ones you won’t be the best-in-class solution. Consequently, you will struggle, and growth will slow.

But, Square has time and time again illustrated that it has the innovation ability to improve and iterate its solutions to become the best-in-class (this is exactly how Square dominated the micro-merchant world). Remember, Square used to be just a brick-and-mortar credit card processor. Now, the company has built a payments processing ecosystem that covers both the physical and digital retail channels, and includes things like Square Capital, Square Payroll, and Square Cash App.

In other words, Square’s track record speaks to the fact any competition-related slowdown today, won’t last into tomorrow. Square will innovate, iterate, and improve, and ultimately continue to win share across the entire payments processing ecosystem.

Long Term Tailwinds Will Last

The long term bull thesis on SQ stock is equally simple. It goes something like this:

There is a huge pivot happening across the world from cash to non-cash payments. Square is at the heart of this pivot. But, the company’s gross payment volume last year amounted to less than 0.5% of global retail sales. Thus, there is plenty of room for Square to grow share in a huge market.

The company is doing everything it can to do just that. They have expanded more aggressively in the digital retail and mobile retail channels, built out multiple services business to complement the payment processing business, and focused more intently on on-boarding big merchants. The sum of these initiatives will ultimately enable Square to continue to grow share in the global payments world.

Unlike the bear thesis, the bull thesis is all about the big picture  and is supported by tailwinds that aren’t going anywhere anytime soon.

The cash to non-cash pivot? Here to stay, because non-cash is more convenient for digital shopping. The mobile payment shift? Also here to stay, since consumers are increasingly addicted to their phones. Square’s omni-channel expansion?

It will continue, because Square has very small and rapidly growing share in the secular growth digital channel. Growth in the services businesses? That will continue, too, since Square can create multiple payments-related services to build out its merchant ecosystem.

Net net, the big picture Square growth narrative looks very good, and the long term bull thesis is supported by unwavering secular growth trends. Ultimately, that means SQ stock will head higher in a long term window.

Bottom Line on Square Stock

Relative to many of its high growth peers, Square stock has been an under-performer for the past several months. But, this under-performance can be attributed to the market overreacting to what is a temporary growth slowdown.

Eventually, as Square builds out share in new markets, this slowdown will reverse course. Once it does, SQ stock will go from under-performer to out-performer.

As of this writing, Luke Lango was long SHOP, TTD, ADBE, ROKU, SQ, and PYPL.

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