Square Q3: Cashing In on a Cashless Future

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The stock of electronic payments processing specialist Square (NYSE: SQ) has been on a real tear this year, and it isn't hard to figure out why. The company habitually beats expectations and delivers growth rates similar to those of a rocket-fueled tech start-up.

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Square did it again earlier this month, reporting third-quarter results that were better than most had expected. Here's a quick and dirty look at how the quarter went.

More bills in the till

Nearly every headline fundamental saw a vast improvement for Square during the quarter:

 Metric Q3 2017 Q3 2016 YoY Growth
Gross payment volume (GPV) $17,386 $13,248 31%
Adjusted revenue $257 $178 45%
Headline net income ($16) ($32) N/A
Adjusted net income $30 $4 718%

The adjusted revenue and net income tallies for the quarter both convincingly beat analyst expectations. This was an excellent quarter for the company in almost all respects.

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Much of Square's growth was powered by increased take-up from mid-market businesses, as opposed to the smaller operations it initially appealed to (and still does, to a great extent). In the third quarter, nearly 50% of overall gross payment volume (essentially, the sum total of all transactions effected through Square's systems) came from clients that booked over $125,000 in payments on an annualized basis, and 20% came from those with over $500,000 in bookings. 

A mere two years ago, those percentages were 37% and 11%, respectively.

What also helped was a robust 84% increase in subscription and services-based revenue compared to year-ago figures, rising to $65 million. That category covers the complementary services Square has either acquired or built recently. These include useful offerings such as Instant Deposit, a quick way for a business to park its money; Caviar, a restaurant pickup and delivery ordering system; and Square Capital, which provides loans for small businesses.

The one slight disappointment in the otherwise shining quarterly figures was forward guidance for the fourth quarter, even though Square anticipates revenue will grow by 37% at the midpoint of the expected $262 million to $265 million range. But adjusted EPS of $0.05 to $0.06 just barely meets the expectations of those who track Square closely. 

It seems investors had expected that strong performance to stretch into the current quarter. That might have been a reason the company's stock traded down slightly in the wake of the Q3 results. 

From bucks to bytes

To an extent, Square is riding a wave of cashless commerce that's been building for a while and will probably continue to swell. Many small and midsize businesses here, and especially abroad, still haven't joined the digital revolution.

The ones that have are lifting the e-payments segment as a whole. Look at PayPal Holdings (NASDAQ: PYPL), the digital transactions specialist Square is often compared to. PayPal has managed to nearly double its revenue over the past half-decade, on the back of total payment volume that climbed steeply from just over $150 billion in 2012 to $354 billion last year.

According to Transaction Network Services data that my colleague Matt Frankel cited in an earlier article about Square, worldwide non-cash transactions are set to grow by 10% to 15% on a year-over-year basis in 2017 alone. It's staggering to think what those numbers might be over the next five or 10 years, once the digital ball really gets rolling.

What's clever about Square is that the company is branching out assertively, but not recklessly, into those aforementioned services.

Restaurant delivery software might not appear to be a complimentary product for a finance company at first glance. But it can provide a good hook with which to reel in eateries that also need a digital payments system, inventory and accounting software, and maybe even a small loan to shore up their business. These days, Square offers all of these services.

I haven't always been bullish on Square, but these days I'm impressed by how successfully it's differentiating itself in the e-payments space. It's morphing nicely into an omnibus financial services provider for businesses in the digital age, and on top of that it'll benefit from the overall migration to cashless commerce. It's come a long way in a short time, and even at a stock price touching historic highs it's a compelling investment.  

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Eric Volkman has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends PayPal Holdings. The Motley Fool owns shares of Square. The Motley Fool has a disclosure policy.