Is Square Stock a Buy? — The Motley Fool

Shares of financial-technology company Square (NYSE:SQ) have been absolutely slammed. Since October 2, the stock has fallen nearly 30%, leaving shares below $70 as of market close on Thursday, Oct. 11.

Just a few weeks ago, Square stock was all the rage. Several analysts set price targets on the stock for over $100 in September, with one price target as high as $125. Further, the stock even briefly surpassed $100 late last month. But after a sell-off of high-growth tech stocks and an announcement that the company’s CFO is stepping down, shares are trading significantly lower than they were a few weeks ago.

Is this a buying opportunity? I think so. Here’s why.

Square Register. Image source: Square.

An overreaction

First, it’s worth going over the reasons Square stock is trading lower to see if those reasons are justified.

The primary reason for the company’s falling stock price recently has been an overall sell-off in the market, especially for high-growth tech stocks like Square. A sell-off like this indicated investors believed the valuations of many of the hottest stocks on the Street were getting ahead of themselves. Companies like Netflix, Amazon, and Facebook, for instance, have all seen their shares take a hit.

Square’s valuation was undoubtedly becoming a little stretched at $100 per share. The company’s price-to-sales ratio was closing in on 15 — well ahead of competitors like Salesforce.com (NYSE:CRM) and Intuit (NASDAQ:INTU). But now Square’s price-to-sales ratio of 10 puts it only at a slight premium to these same peers who both have price-to-sales ratios of about 9.

Square arguably deserves a higher price-to-sales ratio than Salesforce and Intuit. Sure, Salesforce and Intuit do have one massive advantage over Square when it comes to profitability. Both are raking in significant earnings. Salesforce has a net margin (earnings as a percentage of revenue) of about 6%, and Intuit has a net margin of 20%. Meanwhile, Square is still reporting losses (although losses as a percentage of revenue have been narrowing). But Square has a smaller market capitalization — $28 billion versus Salesforce’s $105 billion and Intuit’s $52 billion market caps — and it’s growing much faster.

In other words, while Square’s stock may have been getting a bit pricey, this sell-off seems to have gone too far. Square’s scalable business model and rapid growth easily justify the stock’s more conservative valuation multiples after its sharp decline.

Then, of course, there’s Thursday’s sell-off related to the company’s announcement that its CFO, Sarah Friar, is stepping down. While it’s common for stocks to drop when CFOs step down, there’s nothing fishy about this change. Friar has always wanted to lead her own company, according to CEO Jack Dorsey — and that’s exactly what Friar is doing. Friar is becoming CEO at Nextdoor, a social network for neighbors and communities.  After serving six years at Square amid a period of uncanny growth, it only makes sense that Friar is ready for a step up in her career.

Square’s monstrous growth

Finally, it’s worth going over Square’s mind-boggling growth recently, as it’s a step above the growth seen at most growth companies.

Not only has Square been growing at high rates, but its growth rates have been accelerating. Highlighting the company’s impressive growth, Square’s second-quarter revenue was up 48% year over year. But even more notable is the fact that this represented the company’s fifth quarter in a row of accelerating revenue growth. For some context, in the company’s second quarter of 2017, Square’s revenue increased a much less impressive 26% year over year.

Notably, this momentum far exceeds Salesforce’s and Intuit’s recent growth rates. These two companies grew revenue by 27% and 17% year over year, respectively, in their most recently reported quarters.

Importantly, Square’s scalable business model means its losses are narrowing amid this rapid growth. In fact, Square is close to breakeven. The company’s second-quarter net loss improved from a loss of $16 million in the year-ago quarter to just $6 million. In the same quarter two years ago, Square’s net loss was $27 million.

Looking ahead, there’s good reason to expect Square’s rapid revenue growth to continue for some time. Namely, Square has been successfully attracting more large sellers to its platform. With products catering to larger businesses, like its Square Register and Square for Restaurants platform,  Square is seeing rapid adoption of its products and services by sellers with over $125,000 in annualized revenue — and there’s no sign of this trend slowing down.

Taking into consideration Square’s scalable business model and its mind-boggling growth, a 30% decline in Square’s stock price in less than two weeks is likely an overreaction. For investors willing to hold for the long haul, this may be a good time to buy shares.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Daniel Sparks owns shares of Square. The Motley Fool owns shares of and recommends Amazon, Facebook, Intuit, Netflix, Salesforce.com, and Square. The Motley Fool has the following options: short January 2019 $80 calls on Square. The Motley Fool has a disclosure policy.