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Expect Square to Remain Stuck in Neutral

Thomas Niel

While the market reaches new highs, Square (NYSE:SQ) stock remains in neutral. Square does trade at a high valuation. But with analysts predicting growth deceleration since August, investors have been less confident in giving this stock an even higher valuation.

SQ stock
SQ stock

Source: Jonathan Weiss / Shutterstock.com

Is Mr. Market right in discounting Square’s future prospects? Is Square a software-as-a-service pioneer like Shopify (NYSE:SHOP)? Or is the company more like PayPal (NASDAQ:PYPL) or legacy payment processors like Fiserv (NASDAQ:FISV), Visa (NYSE:V) and Mastercard (NYSE:MA)? Back in October, a Barron’s article made the case for the latter. In other words, implying more downside for SQ stock.

Add in increased competition, and Square does not look like a great opportunity. So, what’s the verdict? Let’s dive in, and see why SQ stock is most likely going to be stuck in neutral in 2020.

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What Does Fintech Consolidation Mean for SQ Stock?

I’ve before discussed how the competition’s heating up for Square. Square’s merchant platform faces growing competition from established players like Fiserv. In retail peer-to-peer payments, Square’s Cash App goes toe-to-toe with PayPal’s Venmo. Square can still expand its merchant and consumer businesses. But customer acquisition costs could skyrocket as the market becomes crowded.

Square has its work cut out for it. Yet, the company could be an ideal bolt-on acquisition for a larger financial services company. Potential acquirers like Visa or Mastercard come to mind. InvestorPlace contributor Dana Blankenhorn expressed similar sentiments in his Dec. 30 SQ stock analysis. Blankenhorn argued that strategic buyers could pay a 33% premium to its then-trading price of $63.50 per share. In other words, $84.45 per share.

Yet, this article came out before Visa’s announced acquisition of Plaid. Plaid provides the back-end technology that allows fintech apps like Coinbase and Robinhood to link with your bank account. Why is this recent deal relevant to SQ stock? It could mean Square isn’t the type of company deep-pocked payment companies are looking to buy.

By owning the key gatekeeper between banks and fintech startups, Visa may not need to buy a company like Square to stay relevant. If businesses and customers pivot toward fintech startups in lieu of legacy payment processors, Visa can still win by owning Plaid. Visa could also leverage its ownership of Plaid to compete with Plaid’s existing clients.

Square was in talks to buy Plaid in 2018. Unfortunately, they couldn’t get their hands on this hot asset. Doing so would’ve given them in edge against both startup rivals, as well as legacy payment providers.

Square Needs Time to Grow Into Its Valuation

SQ stock currently trades for 88.7 times estimated 2019 earnings, and 71.5 times estimated 2020 earnings. In contrast, payment rivals PayPal trades for 38 times 2019 earnings, and 33.3 times 2020 earnings. Their other main rival, Fiserv, trades for 30 times 2019 earnings, and 23.6 times projected 2020 earnings. Square’s faster growth rate does justify a valuation premium. But with risks growth could decelerate, paying 71.5 forward earnings doesn’t look like a smart move.

Could Square grow into its valuation? It could. But even Square’s high projected earnings growth of 23% implies it would take a while. In the meantime, investors may start giving Square a lower earnings multiple, sending shares to lower levels.

So what’s the solution? As InvestorPlace’s Josh Enomoto recently wrote, the company’s Square Capital lending business could move the needle long term. But investors are well aware of Square’s intent to become a fintech “financial supermarket.” Square could win big with this aggressive growth strategy.

But looking at the competitive environment, it seems Square is sandwiched in the middle. On one hand, you have new startups that could outfox Square via innovation. On the other hand, deep-pocketed rivals to use scale to hamper Square’s growth plans.

That’s not to say that Square will be muscled out of business. Yet, growth above expectations seems less likely. With this in mind, it seems SQ stock is more likely to come down valuation-wise than go higher thanks to expectation-exceeding growth.

Bottom Line: SQ Stock Could Stay in Neutral

Square has much potential to further disrupt financial services. However, I do not believe the company’s valuation premium to payment peers like PayPal is sustainable. If February’s earnings call indicates further growth deceleration, SQ stock could fall to a valuation closer to that of peers.

Square’s move to become a fintech “financial supermarket” further cements the argument that the company is not comparable to a SaaS name like Shopify. Square deserves a growth premium to PayPal, Visa and others, but not a forward price-to-earnings ratio of 71.5.

So what’s the call? Stay away from SQ stock. The company could surprise come February. But chances are Square shares tread water at best in the coming year.

As of this writing, Thomas Niel did not hold a position in any of the aforementioned securities.

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