Last month, I wrote about Square (NYSE:SQ) stock using a comparison with PayPal (NASDAQ:PYPL) and concluded it was way too cheap. On June 7, SQ stock closed at $216.95 and I wrote it was worth $250.33.
Since then, SQ stock jumped to as high as $254.78, but has fallen to current levels at $233.69. However, I still think it is undervalued. And based on my new valuation target, SQ stock should rise to $314.55 using the same methodology.
Upgrading Square’s Valuation
For example, I wrote that Square’s 2022 forecast revenue growth would be just 51% of PayPal’s growth rate. I assumed that is why Square had a much lower price-sales (P/S) ratio.
But now, I find that analysts have upgraded their sales forecasts. For example, forecasts for 2022 sales are $22.73 billion, compared to $22.66 earlier. More importantly, its 2022 growth will be 12% over the forecast $20.29 billion in sales for 2021.
Compare this PayPal’s forecast growth rate for 2022. Analysts expect $31.37 billion in 2022 sales, vs. $25.81 billion in 2021. That represents a growth rate of 21.5%.
Therefore, Square’s forward forecast growth rate is 55.8% of PayPal’s (i.e., 12% / 21.5%). We can use that by applying it to Square’s P/S multiple.
For example, PayPal trades for 11.28 times 2022 sales since it has a $352.67 billion market capitalization. So, if we multiply the 11.28 multiple by 55% we get a 6.3 times sales multiple for Square. Right now, its P/S multiple is just 4.76 times.
Here is how that is useful. If we multiply 6.3 times Square’s 2022 sales forecast of $22.73 billion, we get a target market cap for Square of $143.2 billion. That represents a 34.6% increase over its market cap today of $106.42 billion.
In other words, SQ stock has a target value of $314.55 (i.e., 134.6% x $233.69 price today).
What Analysts Say
Right now, 45 analysts on the Sell-side of Wall Street have an average price target of $272.17, according to Seeking Alpha. TipRanks.com also has an even higher target price of $286.90 from their survey of 22 analysts, or over 22% higher than today.
That shows that the Street in general is very positive on the company’s potential growth and upside, just as I am. Much of this based on the company’s amazing growth rate.
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, revenue grew 139% to $529 million for the quarter, and its gross profit was $425 million.
That said, Square expects to release its upcoming Q2 earnings on Aug. 5. In turn, analysts expect revenue of $4.99 billion, compared to $1.9236 last year, or 159% higher. However, consider this. Sales last quarter were $5.057 billion, so the Q2 estimate of $4.99 billion would actually be a quarter-over-quarter (QOQ) decline. However, typically analysts are too low with their Square forecasts, so expect to see the company beat its sales forecasts.
More importantly, analysts now expect to see earnings per share (EPS) of 30 cents for Q2, vs. 18 EPS a year ago. However, again, last quarter EPS was 41 cents on an adjusted basis in Q1. So if the company only achieves its expectations for Q2, this will actually be a sequential decline. This could be due to seasonal effects. But it can’t have QOQ declines each quarter if the company wants to eventually show YOY growth.
What To Do with SQ Stock
My view is that investors in Square stock can expect to see a significant profit and free cash flow (FCF) growth over the next year. Last quarter, FCF was negative, but I believe Square will start producing significant positive cash profits going forward.
In short, higher usage of Square’s Cash App and the reopening of restaurants and related transactions will push cash flow profits higher.
Look for SQ stock to cross over $300 before the end of the year. My view is that it will hit $314.55, 34% higher, based on a comparison with PayPal stock.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.