Square Could Benefit From Increased Marketing Spending

Square (NYSE: SQ) loves to boast about how efficient its marketing is.

On the company's latest earnings call, newly installed CFO Amrita Ahuja pointed to the company's three- to four-quarter payback period for new merchants. That's improved from a couple years ago, when management used to say it was four to five quarters. Square is seeing a positive return on its marketing dollars in less than a year now.

Ahuja also told analysts over 80% of large sellers -- an increasingly important piece of Square's business -- self on-board. In other words, they hear about Square through word of mouth or brand advertising and go to the website and sign themselves up without much effort on Square's part to sell to them.

Square's marketing and sales expense totaled just 12.5% of revenue last year. That's up from 11.5% in 2017, but still relatively low. First Data (NYSE: FDC) spent 27.9% of revenue on selling, general, and administrative expenses last year. Global Payments (NYSE: GPN) spent 45.6%. Square's sales and marketing plus general and administrative expenses totaled just 22.8% in 2018.

These are the companies Square is competing against for large merchant accounts, and it might need to spend more to win them.

Why start spending now?

Square offered a somewhat disappointing outlook for 2019. Management expects adjusted revenue growth of just 41%, slowing over the course of the year. Adjusted revenue grew 61% in 2018, helped by the acquisitions of Weebly and Zesty. Even discounting those acquisitions, adjusted revenue climbed 54%.

Growth in its core transaction-based revenue is slowing despite Square expanding to more large merchants and introducing several new pieces of hardware and software for accepting payments over the past year. MoffettNathanson analyst Lisa Ellis described that trend as "counterintuitive," saying Square needs to do more to get its products into merchants' stores, particularly larger merchants.

Just 24% of Square's payment volume comes from merchants using Square for over $500,000 in annual payment processing. While the company has shown steady improvement in attracting large sellers, they represent a massive opportunity. Square's management even says its goal is to invest in order to take advantage of that opportunity.

Why larger merchants are a bigger opportunity than a bunch of small merchants

Square's competitive advantage over companies like First Data or Global Payments is that it offers an ecosystem of tightly integrated services. Instant Deposits, Payroll, Appointments, Invoices, specialized management software for various verticals, and loans through Square Capital are all tied to Square's core payments platform.

With this growing ecosystem of ancillary services that could be particularly valuable to larger merchants with multiple locations and employees, Square can compete more effectively on pricing with First Data or Global Payments. Meanwhile, the volume of transactions and the number of services larger merchants take should make them more valuable than Square's average merchant. That's an opportunity worth pursuing with additional sales and marketing.

Another factor worth considering is that larger merchants will have a harder time switching providers. That means Square might have to work harder to win their business, but their lifetime value as a customer could be much greater than average.

Square seems reluctant to spend money on marketing and allow its payback period to move back out over a year. But if it truly believes in the long-term opportunity of its payments system and ancillary services, it should take the initiative to get its products into more larger merchants. First Data and Global Payments are growing more slowly than Square, but spending heavily to keep their positions with large sellers. Square can't expect to keep growing mostly by word-of-mouth indefinitely.

10 stocks we like better than SquareWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Square wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

*Stock Advisor returns as of March 1, 2019

Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Square. The Motley Fool has a disclosure policy.