Square Is A Fast Growing Company In A Great Industry

At present, the market is plenty large enough for all of these players without affecting pricing. However, should we start to see competitors resort to price wars to win new business, it would raise concerns. Additionally, should Square's revenue growth trajectory take a massive hit due to competitive deficiencies, it would be another cause for concern.

What's It Worth

One big difference between Square and some of the competitors we mentioned is that, to date, Square is unprofitable - although it should flip to profitability late this year or early next year.

That said, the firm is cash flow positive, which is far more important. While cash profitability is still pretty minimal at this point (4.6% on revenues last year and 2.7% in the trailing 12 months), management has reported "adjusted" EBITDA margins of about 15%. These are a decent proxy for targeted cash flow margins. Similar, more mature competitors like PayPal generate free cash flow margins in the low 20% area. It seems reasonable to assume that Square will eventually be able to generate the same kind of profitability.

To get a valuation, let's lay out some assumptions on top of this 20% long-run free cash margin assumption. We see revenue increasing at 45% this year, 30% next year, followed by a gradual decline from the mid-20's. Share dilution has been meaningful, so we model a 9% increase in shares this year, 7% next year, and 5% for several years after that. We use a target mature P/E ratio of 21, which is fairly conservative for this kind of business. Lastly, a 12.5% discount rate bakes in the reasonable amount of risk faced from an unprofitable business with a lot of strong competition.

After the math, we get a target price of about $79. That makes the company's $74 current price seem like a decent - if not screaming - buy.

Over the long-term, Square looks like a solid business that should do very well for shareholders, and today's price seems like a good place to get in for new investors. 

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