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Is the Afterpay share price a buy?

Is the Afterpay Touch Group Ltd (ASX: APT) share price a buy?

That’s been one of the hottest questions over the past year. The Afterpay share price has risen by an astonishing 340% over the past year. In just 2019 alone it has gone up by just over 100%.

Are the investors buying Afterpay these days just momentum investors? Perhaps the newest investors are people who like the Afterpay concept but pay no heed to valuation? Or are the recent buys being done by fund managers who can see a very promising future ahead for Afterpay?

It’s probably a mix of everything. The buy now, pay later business does not tick many of the typical boxes you’d want to see from a great business idea. It doesn’t make a profit, it isn’t generating free cashflow, it doesn’t have a ‘strong’ balance sheet and so on.

But it does have a few things that are very attractive. It is unveiling enormous growth each result. In the December 2018 report it showed total income growth of 91% to $116.1 million and underlying sales growth of 147% to $2.3 billion.

It also has a very strong brand. Nearly everyone in Australia knows who Afterpay is and it now has a loyal customer following. Indeed, some people have turned it into a verb, “Afterpay it”, and some customers choose to shop where Afterpay is offered.

Another good point about Afterpay is that the total addressable market and the potential addressable market are huge. Retail is huge in Australia. If Afterpay can continue to gain market share whilst clipping a 4% merchant margin then Afterpay could become a much larger business. There’s also the fact that Afterpay is expanding into payments for other industries such as travel, dentistry, eyewear, home appliances and almost anything else you could think. That’s a lot of optionality.

Australia is just one country of opportunity. The US and UK markets are much larger than Australia. If Afterpay can grow in the Northern Hemisphere as it has done in Australia then it could be worth significantly more than the current share price.

Foolish takeaway

However, Afterpay is currently trading at 89x FY21’s estimated earnings. Its valuation is a big risk at the current price. If you invest today you are assuming that Afterpay will be successful in the US and do fairly well in the UK. There’s a risk a recession or a competitor could crimp growth. Of course, there’s a chance Afterpay could significantly exceed expectations.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of AFTERPAY T FPO. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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