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3 Reasons to Be Cautious on Square Stock

Tom Taulli

Since the new year, Square (NYSE:SQ) stock has pulled off an impressive bull move. Consider that Square stock is up about 25% so far in 2019.

Of course, SQ stock has been a reliable winner over the years, although it swoons occasionally. Since SQ went public in early 2016, the price of Square stock has gone from $9 to $72.

The company’s focus on small businesses has been spot-on. By leveraging mobile devices from Apple (NASDAQ:AAPL) and Alphabet (NASDAQ:GOOGL, NASDAQ:GOOG), SQ has been able to amass a large base of customers. But the company has also launched add-on offerings like e-commerce, gift cards, payroll, employee management, inventory, scheduling, etc.

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While all this is great, I actually think investors should still be somewhat cautious about SQ stock. Expectations for Square stock do look overly optimistic, as its business is facing considerable risks.

So let’s take a closer look at SQ.

Square’s Growth

In the third quarter, SQ’s revenues shot up by a sizzling 68% to $431 million. Its top line handily beat the expectations of Wall Street analysts, whose average estimate was $414 million.

Yet it will certainly be tough for SQ to maintain that blistering growth. In fact, its top-line increases could slow soon.

Consider a recent research note from Raymond James analyst John Davis on Square stock. According to the analyst, SQ does not have any upcoming product offerings that will generate revenue growth. Davis adds that the company’s acquisitions of Weebly and Zesty are likely to weigh on its bottom line.

Davis concludes his note on Square stock by writing: “We believe organic growth peaked in 3Q18 and growth on the all-important subs and services line will likely materially decelerate in 2Q19. We believe the risk/reward is negatively skewed and recommend investors reduce positions.”

He downgraded Square stock from “Market Perform” to “Underperform” and lowered his price target on SQ stock to $56.

Square’s Competition

There are plenty of companies that are gunning for Square’s customers. For example, Intuit (NASDAQ:INTU) has capitalized on its QuickBooks business to provide loans to small businesses. While its loan initiative is still in the early stages, it has gained a great deal of traction so far.

Then there is PayPal (NASDAQ:PYPL). The company’s payments business continues to grow at a rapid pace, led by its Venmo app, which has become a must-have for Millennials. PYPL is also acquiring iZettle, which is a leading player in merchant processing systems for smartphones and tablets in Europe.

Even traditional financial institutions are becoming a major factor in the digital payments industry. A consortium of banks – including Bank of America (NYSE:BAC), BB&T (NYSE:BBT), Capital One (NYSE:COF), JPMorgan (NYSE:JPM), PNC Bank (NYSE:PNC), US Bank (NYSE:USB) and Wells Fargo (NYSE:WFC) – have developed a digital-payments app called Zelle. No doubt, the app has gotten a nice boost from its wide distribution. Consider that the volume of BAC’s Zelle offering has more than doubled over the past year.

Finally, there was the recent merger between Fiserv (NASDAQ:FISV) and First Data (NYSE:FDC), which are major credit-card processors. The companies made the deal mainly to more effectively take on Square. The combined company plans to spend $500 million over the next five years on new technologies.

The Valuation of Square Stock

SQ stock is far from cheap. The market cap of Square stock stands at $30 billion, and it has a price-sales ratio of nine. And if Square’s growth decelerates and SQ starts to look more like a bank, the valuation of Square stock is likely to drop

What’s more, it’s important to note that Davis is not the only Wall Street analyst who is skeptical about Square stock. BTIG’s Mark Palmer and Giuliano Bologna have a price target of $30 on Square stock!

That may be a bit extreme. But then again, the average price target on SQ stock is roughly $78, which assumes only about 11% upside from current levels.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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