Why Square Is Up 85% So Far in 2018

Payment-processing and fintech company Square (NYSE: SQ) has done incredibly well for shareholders, having more than doubled in the first nine months of 2018. Soaring revenue, new products, and investor optimism are responsible for the excellent performance, but the stock has actually performed poorly in recent weeks due to some negative catalysts.

With that in mind, here's why Square has performed so well, and why shares could actually be a bargain at the current level.

Square's core business continues to grow impressively

Square's main business is its payment-processing hardware, and it continues to grow at a rapid pace. In the most recent quarter, Square's gross payment volume (GPV) grew at a 29% year-over-year rate.

It's also important to mention that the GPV of $22.5 billion in the third quarter translates to an annual rate of $90 billion, which is still just a small fraction of the company's addressable market opportunity. So it's certainly possible that this growth rate could be sustained for quite some time.

Other revenue streams are growing even faster

Square's adjusted revenue grew by an astounding 56% over the past year, propelled in large part by the company's other revenue streams.

Specifically, Square's subscription and service-based revenue grew by 155% year over year. This includes Square Capital, the company's business loan origination platform, which originated $405 million in loans during the third quarter (34% more than a year ago), as well as Square's Caviar food-service platform, the Cash Card, and the Instant Deposit service.

The company's new hardware offerings have also been rather successful. The company's Square Register and recently launched Square Terminal have been selling well, and the upgraded Square Reader is still a popular product. In all, hardware revenue, while a relatively small portion of the total, grew by 74% year over year.

Because of the excellent growth, Square has increased its full-year guidance along with each earnings report it has issued in 2018. The company is now expecting revenue to come in about 19% higher than originally projected.

The most powerful growth engine could still be untapped

Square's core payment-processing business, the Square Capital business lending platform, and the company's other revenue streams are certainly performing very well, but it's possible that the best long-term growth driver hasn't even begun to scratch the surface of its potential.

I'm talking about the Square Cash person-to-person payment app, which has been downloaded more times than Venmo and has millions of active users.

To be clear, Square isn't really making much on the Cash app yet. In fact, considering that the company is paying for the Cash Boost rewards program out of pocket, the app is probably losing quite a bit of money for the time being.

Having said that, the app is building a massive user base that can eventually be monetized in some big ways. For example, Square could offer personal lending products, an investment platform, savings accounts, and more that can be cross-sold to the company's loyal Cash App users.

To give you an idea of how big of an opportunity this is, consider that the Cash App had about 7 million active users as of last December, and this number has likely grown since then. For comparison, Square's merchant-focused businesses currently have about 2 million customers.

Square was up a lot more until recently

As a final thought, it's worth pointing out that although Square has more than doubled in 2018, the stock has actually pulled back quite a bit recently. In fact, since peaking in late September at over $100 per share, Square has declined by 35%.

This is due to a combination of reasons. First, CEO Jack Dorsey sold more than 100,000 shares of stock. Then, the company announced the upcoming departure of highly successful CFO Sarah Friar, which was the biggest negative catalyst. And most recently, while Square's earnings continue to show impressive growth, the company's fourth-quarter guidance wasn't quite what the market had hoped for.

So, if you were waiting for an entry point in Square, now could be the time. The stock's upward momentum in 2018 has been well-justified, and I can't make the case that the company is worth three-quarters of its share price of just over a month ago.

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Matthew Frankel, CFP owns shares of Square. The Motley Fool owns shares of and recommends PayPal Holdings and Square. The Motley Fool has the following options: short January 2019 $82 calls on PayPal Holdings and short January 2019 $80 calls on Square. The Motley Fool has a disclosure policy.