Although we are oriented towards long-term investments in structural growth companies, we are also aware and cautious of valuation.
Let’s revisit Square’s ($SQ) valuation, now that it is up 50% since we started buying it on the Big Board on Sep 24, 2020 and is now trading at 22.7x forward Gross Profit.
If you look at the chart, in order for $SQ to be worth 21x forward Gross Profit with a 9% discount rate, you need to believe that the company grows revenues at a 21% compounded annual growth rate (CAGR) for the next 10 years, essentially multiplying their current revenue by 6.5x. We also need to believe they improve cash flow margins to 15% over that time.
I believe margin expansion to 15% is achievable, but we should also understand the magnitude of the growth assumptions. $9.1 billion in cash flow in Year 10 is 22 times their current situation. This assumes that in 2030, Square will make 50% more than PayPal ($PYPL), as much as Mastercard ($MA), and 60% as much as Visa ($V) currently make.
And if these assumptions are true, then $SQ should be worth somewhere around $210 per share. Investing behind $SQ at this valuation is a bet that “New FinTech” will become behemoths alongside Visa and Mastercard. I believe this will happen over time, but the speed and magnitude of future growth is uncertain and the valuation is looking stretched.
We will consider trimming back on positions like this on the Big Board in the coming weeks, which will show up under “Latest Trades”.