Square (NYSE:SQ) reported better than expected revenue and earnings for Q1 on May 6. For the first time, its Cash App gross profits exceeded Seller profits. This has significant implications for Square’s future profitability. And it also means that SQ stock is too cheap.
I estimate the stock should trade at least 16% higher from current prices. SQ stock currently trades at $215.18, putting its target value now at $250.13.
Square’ Stellar Earnings
In the quarter ending March, gross profits from the Cash App, its consumer payments business, grew 171% year-over-year (YoY) to $495 million. Not including Bitcoin (CCC:BTC-USD) sales, its revenue grew 139% to $529 million for the quarter, and its gross profit was $425 million.
By comparison, Seller side gross profits (i.e., from its merchant payment business) grew just 32% YoY. This gross profit came in at $468 million, which is less than the Cash App gross profits of $495 million.
This was the first time that Cash App gross profits were higher than the Seller side profits. Last month I predicted that this would happen. I also argued that Square stock is worth $333, based on a comparison with PayPal (NASDAQ:PYPL).
Analysts were also excited by company earnings. Mark Palmer of BTIG wrote that Cash App’s growth was driven by its Cash card. He said that it “has the greatest scale of any product offered in the app’s ecosystem and reached more than 10M monthly active users during March.”
What does this really mean? Square makes money charging transaction fees on its gross payment volume (GMV). The GMV for the quarter ending March was $33.138 billion, up 28.7% YoY from $25.743 billion last year.
But more importantly, the revenue from its GPV grew from $1.381 billion to $5.057 billion. This implies that its take rate (i.e., revenue divided by GPV) grew from 5.36% to 15.26%. Most of this gain came from Bitcoin transactions via Cash App.
This higher take rate also led to significantly higher profits. For example, EBITDA (earnings before interest, taxes, depreciation and amortization) grew 78.95% from $538.5 million to $963.5 million.
Where This Leaves SQ Stock
As I wrote last month, Square stock trades for a significantly lower price-to-sales ratio than PayPal. The discrepancy has only widened since.
For example, last month I wrote that PayPal traded at 9.45 times its 2022 sales, whereas SQ stock was at 6.22 times. Now, the multiples have widened. For example, Seeking Alpha reports that PayPal’s 2022 P/S ratio is at 9.86 times, but Square is at 4.29 times P/S.
The reason is simple. Analysts have dramatically increased their estimates for 2022 sales at Square. Last month the estimate was for $16.93 billion (see my article), but now they believe 2022 sales will hit $22.66 billion.
Using PayPal’s P/S multiple and applying it to SQ stock’s 2022 revenue, the result is $214.137 billion. That represents a potential gain of nearly 120% in SQ stock.
Using a Lower Multiple
But not so fast. PayPal’s revenue is forecast to grow twice as fast as Square’s. Its 2022 revenue will be 21.39% higher at $31.33 billion over 2021 forecast revenue. By contrast, analysts estimate that Square’s 2022 revenue at $22.66 billion will be just 11% higher than its 2021 sales. That means that Square will have about 51% of the growth rate of PayPal (i.e., 11% / 21.39% = 51%).
So, if we use 51% of PayPal’s 9.86 P/S multiple and apply it to Square’s 2022 sale, we get a value of $114 billion (i.e., $9.86 x $22.66 billion = $113.84 billion). This implies that SQ stock should trade 16.24% above its market value of $97.93 billion today.
That puts the price target for SQ stock at $250.13 per share (i.e., $215.18 x 1.1624 = $250.13). This is a conservative estimate of its value right now and still represents a very good ROI for most investors. As its revenue grows and starts to approach the PayPal growth rate, expect to see SQ stock’s target value increase as well.
On the date of publication, Mark R. Hake held a long position in Square and Bitcoin but no other security mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.