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Should Investors Buy Square Stock After Its Recent Decline?

Tezcan Gecgil

Square (NYSE:SQ), the mobile payment fintech (financial technology) company, is expected to report earnings on Nov. 6. In recent years, “fintech” has become one of the most popular buzzwords in the markets. Although it started as a payments company, Square has in recent quarters introduced a range of software, hardware and apps to service small businesses and individual clients.

Should Investors Buy Square Stock After Its Recent Decline?

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In 2019, SQ stock is up about 14%, but lately has taken a beating. Square shareholders are now wondering if they should consider buying the stock prior to the earnings release.

I do not think long-term investors should rush to buy into the shares just yet. When SQ stock reports earnings in a few weeks, Wall Street will be able to better gauge the financial health of the company. Here is why:

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Can SQ Stock Shake Off Earnings Season Jitters?

On Aug. 1, the payment-solutions company reported Q2 earnings that were better-than-expected. Its total net revenue increased 44% year-over-year to $1.17 billion. And on an adjusted basis, earnings were 21 cents per share, beating Wall Street’s expectation of 17 cents per share.

Its payments processing business, also referred to as “payments as a service,” has been a game changer in serving small businesses. Square’s subscription and services-based revenue increased 87% to $251 million. Primary drivers behind the growth include the Cash App, Square Capital, and Instant Deposit. Cash App’s quarterly revenue of $135 million especially impressed the Street.

Gross payment volume (GPV) of $26.8 billion increased from $21.4 billion year-over-year. Square defines GPV as the total dollar amount of all card payments processed by sellers using Square, net of refunds.

The quarterly report once again confirmed that SQ stock is a high-growth equity. Such shares in general are far more volatile than market indices or mature companies. Whenever investors feel growth expectations need to be toned down, they sell the stock first and ask questions later.

Investors were especially concerned by the company’s lower-than-expected Q3 guidance. Its Q3 adjusted-EPS guidance of 18 cents to 20 cents trailed the average estimate of 22 cents. Square management now expects Q3 adjusted revenue to be between $590 million and $600 million as opposed to the consensus of $599 million.

Square stock’s losses on the bottom line are also projected to be higher than expected. And many shareholders have likely felt that for the rest of the year, SQ stock may face a rising tide.

Square Is a Growth Stock in a Competitive Industry

According to a recent World Bank research paper by Juan Cortina and Sergio Schmukler, “… the trend toward digitalization and technological innovation will likely reshape the global financial sector and the ways in which financial companies interact with their customers.”

Square’s rather sticky ecosystem combines software with hardware to especially enable sellers to turn their mobile devices into point-of-sale (POS) solutions. Through various growth initiatives, management is now aiming to make the company a major player in the fintech sphere.

The global payments industry is a $100 trillion-plus market. Such a big industry inevitably attracts both domestic and global competition. SQ stock faces competition from many companies, including the global online payments group Paypal Holdings (NASDAQ:PYPL), transaction processing leader Visa (NYSE:V) and Fiserv (NASDAQ:FISV), which is shaping up to become a global payments giant as well.

A growth stock like Square trades on forward sales as well as the momentum provided by future expectations. While Square currently enjoys a head start in serving small businesses, Wall Street has questions as to whether the group can maintain growth quarter after quarter. If the U.S. economy slows, Square’s growth may start to decelerate rather quickly. Therefore, throughout the year, the SQ stock price has been extremely volatile.

Furthermore, Square is not yet profitable. Its net loss was $7 million in Q2, compared to a net loss of $6 million in the year-ago quarter. The company has reported net losses in five of the last six quarters.

Efforts to attain profitability are taking time. Moreover, not every area Square expands into will necessarily produce easy profits. And unless it increases its revenue, Wall Street may take down the high valuation of SQ stock.

Square Stock’s Rich Valuation

Following the initial public offering of Square stock in late 2015, its price surged from $9 to an all-time high of $101.15 in October 2018. Yet over the past year, SQ stockholders have noticed a decline in the growth rate of its gross payment volume. Between July 2017 and the end of June 2018, GPV grew about 30%. Now growth hovers around 25%. Wall Street tracks this metric widely.

As growth has declined, so has the share price. Now the shares are hovering around $64. Although the decline in Square’s stock has improved its valuation, the shares are still richly valued.

Most SQ stock holders are well aware that the shares do not trade at bargain-bin valuation ratios, especially compared to its competitors. For example, SQ’s forward price-to-earnings ratio is over 56. On the other hand, forward P/E ratios for PYPL, V and FISV stocks are about 29.5, 28.5 and 25.7 respectively.

Similarly Square stock’s current price-to-sales ratio is over 6.9x. Companies generate revenue from the sale of goods and services. Analysts prefer a low P/S multiple, ideally below 1x. However, a P/S number between 1x and 2x is more common. To put the metric into perspective, S&P 500’s average price-to-sales ratio is 2.1x.

In short, I do not think there is much room for Square stock’s valuation to head higher in the final quarter of the year. Sooner or later, SQ stock’s valuation and revenue growth will be more in balance.

Technical Charts for SQ Signal More Volatility

Let us briefly remember how the Square stock price has acted over the past year.

SQ stock went on a big tear during the summer of 2018, baking in plenty of euphoria. However, it had a rough patch after reaching the all-time high in October. By late-December 2018, SQ was hovering around $50.

In 2019, although SQ stock is up about 15%, August has seen the start of a downtrend in the stock. That’s of course due to the weak Q3 guidance.

Before this, shares had been up over 45% for the year ahead of the Q2 quarterly results release. On earnings day, Square stock closed at $80.98. The next morning, SQ shares gapped down to open at $70.80. By Sept. 24, the stock saw a low of $54.41.

From a technical perspective, I’m not expecting Square stock to make another significant leg up prior to the earnings report. In the next few weeks, shares are likely to be range-bound between $60 and $65, a range where SQ stock has strong support. However, if any negative headlines flash that affect the technology or fintech sectors, then shares may easily go below $60.

Square stock will need to stabilize and build a base again before a long-term sustained leg up can occur. Consequently, investors need to be careful about chasing shares at this point, especially prior to the earnings report.

The Bottom Line on Square Stock

The so-called fintech revolution is changing the way traditional banks, credit card issuers and mobile-payments companies work with businesses as well as retail customers. Square is providing merchants with a wide range of tools and services to start, run, and grow their businesses.

Therefore, over the long term, I would not bet against Square stock. In the short-term, though, stakeholders shouldn’t expect smooth sailing.

Square is a high beta stock at 3.3. The stock market has a beta of 1. SQ stock’s beta measures its volatility in relation to the market. In other words, Square stock rises more than the market in bullish conditions and decreases more when markets are falling. Short-term traders should exercise caution if they want to participate in SQ stock’s wide daily swings.

The upside momentum can build up only when long-term investors feel that the SQ stock price justifies the future growth expectations. Thus Wall Street would want to see the next quarterly results to judge whether the current investor skepticism is warranted.

Analysts are likely to pay special attention to metrics that would indicate Square stock’s potential to continue growing sales and earnings over the next several quarters. I personally would not take sides as to whether the share price will go up or down when the group reports earnings soon.

Investors with a 2-3 year time horizon may consider any further price decline in Square shares as a good buying opportunity.

At the time of writing, the author did not hold a position in any of the aforementioned securities.

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