“No. 1 Tech Stock for 2021” and the “End of the Dow”

By Travis Johnson, Stock Gumshoe, January 12, 2021

Yesterday it was someone pitching the “No. 1 Income Play of 2021,” today it’s the “No. 1 Tech Stock for 2021” — that’s the nature of January, it’s prediction time and everyone wants to stake their claim on prescience.

This one’s from Ian King, who’s pitching his Automatic Fortunes newsletter ($97/yr) and talking up the “fastest tech boom in history” — we’ve all gotten that story drummed into our heads in recent months, the quotes about “ten years of digital transition squished into six months” or “three years of growth in two months” are everywhere right now, and they make intuitive sense. We’ve all seen the instant change in so much economic activity from offline to online, whether that’s ecommerce or digital collaboration at work or digital school or social lives or play for kids (OK, for the rest of us, too), it’s clear that a lot of what many folks saw as continuing trends took a big leap forward in 2020.

Ian King goes bigger with his predictions, of course, since he’s trying to get your attention — he talks it up as if we’re living in 2050 right now, with 30 years of advancement happening in the blink of an eye, and I’d say that’s a little outside the mainstream thinking… but who knows, it’s a big shift and none of us is granted a crystal ball. Here’s a little bit from the ad, to get you started:

“This massive tech boom is just starting…

“Six out of every ten Americans say they will stick to online banking.

“Seven out of every ten companies expect working from home to be permanent … saving millions of dollars for both employees and companies alike.

“And eight out of ten consumers plan to continue to shop online.

“Which is why businesses are accelerating their investments in new technology … putting billions into the digital world.

“Upgrades that were scheduled for 10, 20 and even 30 years in the future are happening today.

“Projects that were on the “to-do” list moved over to the “do-now” list.

“And the government is stepping in to make sure this tech boom isn’t just possible … it’s virtually guaranteed. They just proposed a massive bill to fuel digital upgrades saying it’s both ‘urgent’ and ‘critical.'”

That hasn’t gone unnoticed on Wall Street, of course, so it’s an open question we ask about how much of this growth is already “priced in” (the tech-driven Nasdaq index, after all, is up 45% or so in the past year… in the midst of what for a quarter or so of the population is an unprecedented economic catastrophe)… but clearly, King sees some kind of big potential for at least one stock. Whichever one might it be? Here’s the first tantalizing bit…

“It’s a company so revolutionary InvestorPlace calls it ‘one of the most disruptive stocks in the world’ and others call it a stock to hold … ‘forever.'”

What other hints do we get about this company?

“I want to give you my No. 1 stock to buy right now … a company crowned the most disruptive stock in the world.

“I think buying it today could be like buying Apple or Amazon early on….”

And he implies that it’s in “phase 2” of the adoption and innovation cycle:

“Phase 2 is breakout … this is when everything is lined up. The founder is still running things, the vision is coming to fruition, and demand for the product, or service, is soaring. Usually, at this stage, the company is on the verge of disrupting a big industry. It’s relatively low risk, high reward.”

How about his criteria for picking these “next winner” tech stocks? Here’s how he sums it up:

“1. Be in a growing, billion-dollar industry….

2. The company must have a proven CEO. I want CEOs who have a track record of creating and running businesses….

3. The company must have annual revenue growth over 20%….

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4. Investing cash into its future growth. It needs to be creating new products, testing new markets and acquiring competitors, rather than paying off debts, buying back stocks or financially manipulating its share price….

5. That’s the catalyst. The catalyst is a trigger that sends the stock from phase 1 to phase 2. Most people can’t see this…not even the experts on Wall Street….”

And the example he gives is Tesla, he says part of his argument for picking TSLA a while back was that the stock had huge short interest of 24% when it was around $45 in mid-2019, and the “short squeeze” that would come if they started to improve would help send the stock soaring. Here’s how he puts it:

“At the time I made this prediction, Tesla had fallen over 50% from its peak and some analysts were calling for the stock to plunge 80% … others said it would drop to $0 a share.

“But thanks to my Innovation Breakout Curve, I knew better. I knew that it had massive potential.

“And less than a year later, the stock soared way past my 400% estimate. So, I recommended selling half the position for a 552% gain in July. And then, on September 1, I said to sell the other half for a 919% gain.”

Probably kicking himself a bit, too, if he had held on for another six months that would have been nearly a 2,000% gain… but nobody picks the top, and Tesla was absurdly valued in September, too, so I don’t blame him for selling (this ad just started hitting my inbox this week, but it’s dated “October 2020”). I’ve never been able to convince myself to buy Tesla, personally, mostly because I didn’t trust Elon Musk and any valuation rationale seemed fantasy-based, and clearly I’ve been wrong there.

But anyway, what does that tell us about his latest “#1 stock?” Any more hints? From the pitch:

“I think my number one stock could follow Tesla’s parabolic trajectory.

“And I am not alone.

“Hedge fund manager Joel Greenblatt just invested $6.7 million in this company.

“Billionaire David Tepper invested even more … $60 million.

“And founder and chairman of Fisher Investments, Ken Fisher, invested a massive $196 million.”

So this won’t be all that tough for the Thinkolator, those are some solid details… and King is feeling pretty generous, because the hints keep coming:

“… this company is disrupting the $74 billion payment processing industry….

“It’s a leader in the financial technology industry, or fintech, for short. It allows any business owner to turn their smartphone into a cash machine….

“… a business owner can start using this device for free.

“In return, our No. 1 fintech stock takes a 2.65% fee on every payment.”

OK, so this is one of the payment processing companies, all of which are also larding up that relationship with connections for other online services, from payroll to lending to inventory management — but which one? They all charge similar processing fees (gosh no, it’s not a fixed market! Why would you say such a thing? This is a coincidence!)

No fear, there are yet more clues:

“The CEO has a strong track record starting companies such as Twitter and helping others, such as Disney, while they were creating Disney+. So we can count on him to do it again. And the C-level executives have a lot of skin in the game. The top three directors each have over $60 million at stake….

“And the revenue growth is unreal. It’s grown over 50% a year for five years in a row … from $1.2 billion to $4.7 billion. The company is actually hauling in $1.2 million per employee … compare that to ADP which brings in $242,000 per employee. Again, this tech company is going to rise to the top, fast.”

So… hoodat? This tells us that Ian King is actually about a quarter behind with his data, so this ad is probably culled from a newsletter recommendation that he made a few months ago, but here he’s teasing the payments giant Square (SQ).

And I certainly didn’t think I’d see this day when I was speculating on Square a couple years ago (I don’t own it today), but Square is now a $100 billion company. Wow. And yes, online payments and touchless transactions have sent the revenue growth soaring in 2020, as of last quarter they were posting 140% revenue growth. Not every tech stock has seen shocking and historical acceleration in its core business, but the payment and e-commerce folks certainly have.

Those notable investors have been meaningful investors in Square, and the ones I checked do still hold shares, though those numbers are old — David Tepper last quarter was taking profits on his Square position, though he still holds shares, and Joel Greenblatt sold most of his Square position in the Fall but does still own about 5% of what he held earlier in the year (and that could have been worth about $6.7 million after he culled his stake in the September quarter, I suppose, if you go by the prices when Square was trading around $125 in July). And yes, the other clues also match perfectly — Jack Dorsey, Square’s founder, also founded Twitter (and he continues to serve as CEO of both companies), and he was on Disney’s board for about five years (he stepped down in 2018). And Square’s revenue in 2019 was $4.7 billion, though that has grown dramatically — as of September, the trailing four-quarter revenue hit $7.7 billion.

Like most tech companies who are in “growth” stage, Square has somewhat intentionally delayed profitability, continuing to reinvest heavily into expanding the business with marketing and R&D spending instead of maximizing profits, but, also like many near-peers, the growth was so wild in mid-2020 that they posted a profit almost despite themselves. They’re likely to be sustainably profitable now, with this much larger customer base, but they’re still being bought for growth and excitement and ‘own the future’ reasons, not because the profit justifies the valuation — today, Square is trading at about 200X forward earnings.

The good thing is that they can grow into that valuation — if they maintain a strong trajectory in their fast-growing sector, and can protect their margins against the competition, then they’ll likely double that earnings number within the next few years. The bad thing is that we don’t know what will happen in those intervening years.

With companies at these valuations, you’re buying the future, and while it’s clearly a leading company with a strong brand and a strong and high-retention customer base, buying the future is different than buying the present. If Square has a surprisingly bad quarter, as used to happen from time to time with high-growth and high-expectation companies (remember those days?), the stock could fall 40% overnight. That’s not to try to talk you out of a position, Square is a great company, but go into it knowing the risks.

If you want to think about a comparison, there are plenty of payment-system competitors, including dinosaurs and goliaths like Visa and Mastercard and Apple and Google and Amazon, but I’d argue that PayPal (PYPL) is the most similar large company to Square — PayPal is more focused on online sales and Square more on in-person sales, but the valuation and financial performance is very similar.

PayPal is 3X the size of Square, and has a much longer history, so it is not growing revenues as fast… but it’s far more profitable, and growing profits much faster. Both trade at about 13-14X sales, with a Return on Equity of about 18%, and their stock charts over the past five years are essentially the same shape, it’s just that Square’s is exaggerated and shows higher returns on that same trajectory (this chart is in Log scale, to de-emphasize the cumulative impact and look at annual returns), and most of them have been quite impressive compared to the average big technology stock (Square in blue, PayPal in orange, the Nasdaq 100 is in red — and I threw in Mastercard in green, just for comparison):

SQ Chart

And if you want to think of Square as “cheap,” you might look no further than upstart Lightspeed POS (LSPD), which in some markets competes with Square (though Lightspeed was founded with more of a restaurant focus), and trades at 40X sales, with about the same gross margin as PayPal (60%, much better than Square’s 26%), but half the revenue growth — mostly because Lightspeed is better at selling its POS software than at getting customers to use its payment processing service. The conundrum for most companies in the shopping cart/POS space is that selling a service and a software platform (almost always as a subscription) is much more profitable than processing payments… but payment processing volume drives much faster revenue growth if you really get that flywheel going. You want both to grow a sustainable giant, as Shopify (SHOP) will tell you, but software subscriptions at an 80% margin look better on the income statement than payment processing and other “service” businesses (shipping, selling physical terminals, etc) at a margin of probably more like 30%.

What happens to all these kinds of companies if the Nasdaq falls by 30%? That I don’t know, sadly, but clearly all the tech stocks trade together… and Square has been one of the more impressive ones in 2020, with a fair amount of that sticky customer base likely to stay strong in 2021, particularly as local retail recovers more fully in the re-opening world post-pandemic. There’s also some risk that the lingering economic impact of the pandemic and the ensuing recession and business closures will bring some hiccups along the way for Square, as some retailers go out of business, but that impact has so far been pretty clearly overwhelmed by the new customers/online ordering/touchless payments adoption rates during 2020. And the (mostly wealthier and white-collar) folks who have not been terribly hurt by the pandemic lockdowns have a lot of money to spend in 2021, with or without a big new wave of federal stimulus/rescue spending. Square even tries to keep a toe in the bitcoin market, as it was one of the first to give regular folks easy access to buying bitcoin through the Square Cash app (which is for person-to-person cash transfers), but hasn’t gotten as much attention in that area as it did a few years ago.

I can’t quite talk myself into buying Square at this point, but in part that’s because I’m already pretty overweight in companies that are growing very fast and trading at nosebleed valuations — there is certainly still a justifiable case to be made for Square, and it’s mostly based on their still-small market share in the broader payments business, I’m just not looking to add that kind of risk profile to my portfolio at the moment (plenty of the other stocks in the Real Money Portfolio have had very similar years to Square — you know the names, firms like Roku, Shopify, The Trade Desk, Docusign, and you could probably name a half-dozen from your portfolio — and that performance has been driven both by revenue growth and by multiple expansion, which increases the odds that they’ll all fall together if sentiment about the future shifts quickly at some point).

The overall payments industry is still huge, digital payments continue to grow everywhere in the world, and Square is still a fairly small part of that, so there is no immediately obvious ceiling on their growth — Mastercard and Visa between them process something like $20 trillion a year in payment volume through their systems, and Square is just over $100 billion at this point (they’d have to grow their business 10X to catch up with even PayPal’s roughly $1 trillion volume). They’ll face competition, and competition could erode margins over time, but so far the “bite” that payment processing companies have been able to claim from digital transactions has remained pretty steady in this oligopolistic world. Shopify has been trying to compete with the big guys, too, pitching its own payment platform within Shopify’s e-commerce universe, and they’ve been growing that very fast and making money from it… but still failing to really make a dent in the market share of anyone else, SHOP’s payment volume is only about $50 billion a year despite its stronger e-commerce positioning.

And the payment processor I’m most interested in remains Stripe, which has sadly not yet gone public (and will probably be at a ludicrous valuation if it ever does), but to some degree we probably shouldn’t worry too much about market share and competition in a sector that is growing so very fast — despite the gigantic power of Mastercard and Visa, this is not a winner-take-all business… all of these companies have had extraordinary growth in recent years.

So make your own call, friends, and do let us know what you think — ready to chase Square on Ian King’s say-so? Think its best days are behind it? Have other favorite plays on electronic payments? Let us know what you think with a comment below… thanks for reading!

Disclosure: of the stocks mentioned above, I own shares in Shopify, Roku, The Trade Desk, Google parent Alphabet, Docusign, and Amazon, and call options on Twitter. I will not trade in any covered stock for at least three days, per Stock Gumshe’s trading rules.


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