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Can the Momentum of Square Stock Continue?

Tezcan Gecgil

Square (NYSE:SQ), the financial services and mobile-payments company, is expected to report its second-quarter earnings on Aug. 7. Of course, the report could have a major impact on SQ stock.

Buy SQ Stock As Square Enters the Next Stage of Its Life

Source: Chris Harrison via Flickr (Modified)

The global payments industry is a $100 trillion plus market. And the financial technology (fintech) apps revolution is quickly changing the way traditional banks, credit-card issuers and mobile-payments companies work with businesses as well as with their retail customers. Therefore, over the long term, I would not bet against SQ stock, the fintech payments company that is regarded as a disruptive force in the sector. In the short-term, though, SQ stock is likely to be choppy.

Square Stock’s Ecosystem Is Growing

Square was co-founded in February 2009 by Jack Dorsey, who is also the CEO of Twitter (NYSE:TWTR). This innovative financial services company has expanded quickly,  with its unique dongles for mobile phones that enable virtually everyone to accept credit-card payments.

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Square has come a long way since its more humble beginnings. Although SQ started as a payments company, in recent quarters it has introduced a range of software, hardware and apps for small businesses and individual clients. Square’s ecosystem also includes business loans, payroll services, point-of-sale solutions, and omnichannel commerce.

For example, SQ’s peer-to-peer mobile payments product, Cash App, has more than 15 million monthly active customers. Square charges businesses that accept Cash App payments 2.75% per transaction.

Management would like to see Cash App become more like a traditional bank whose core customers are small businesses as well as individuals. As the younger generations especially are making a drastic shift to using electronic payments, Square would like to benefit from that growth.

Indeed, SQ has recently applied to become a traditional bank. Becoming a bank could jump-start Square’s long-term growth, eventually driving SQ stock higher.

In other words, through various growth initiatives, SQ is now aiming to become a major player in the fintech apps sphere as well as a small business platform that offers a wide range of services.

When Square acquires a new client, it may be able to sell other services to the client.  Therefore, the future of SQ stock is partly dependent on the number of new clients it can attain and partly on the range of services it can offer.

Released on May 1, its most recent earnings report and accompanying shareholder letter provide a good overview of the growth of its service offerings. Square’s business model is evolving as the global payments space develops.

The Fundamentals of SQ Stock

Clearly, SQ is expanding its services and merchant ecosystem across different channels, and many growth investors are bullish about the long-term outlook of Square stock. However, they need to examine how each business that Square is now creating will contribute to its bottom line.

While SQ currently enjoys a head start in serving small businesses, Wall Street has some questions about whether it can maintain that growth. If the U.S. economy slows, Square’s growth may start to decelerate rather quickly.

As a company that was founded in 2009, Square has not yet lived through an economic downturn. In other words, if the U.S. economy stalls, investors do not yet know how Square’s management will respond. Additionally, since most of Square’s customers are small businesses, which tend to be more vulnerable to economic hardships,Wall Street does not yet know how SQ stock may react if the economy sours.

Moreover, not every area Square expands into will necessarily produce easy profits for the company. And unless SQ increases its revenue, Wall Street may not be too forgiving of the high valuation of SQ stock. Therefore, I’d urge long-term investors to be cautious about Square stock at its current levels.

In investing, it is not enough to personally like a potential product or service offering; instead, investors should also search for companies that have catalysts which can drive the value of their stocks higher.

But many analysts are now expressing doubts over Square’s expansion into lending and questioning whether SQ is taking on too much risk.Another area of potential concern is the declining growth of its transaction fees, which still generate the majority of its revenue. Square’s shifts toward subscription and services revenues may not make up for the decelerating growth of its transaction fees.

Square’s most recent earnings report showed that the company’s gross-payment volume grew a relatively modest 27% year-over-year (YoY) to $22.6 billion, causing Wall Street to become concerned about the outlook of Square stock. However, Square’s gross revenues increased 43% YoY to $959.36 million.

Yet SQ stock’s quarterly net loss was $38 million, or 9 cents per share, compared with a loss of $24 million, or 6 cents per share a year ago.

Moreover, management’s subdued outlook disappointed the market, and investors penalized SQ stock in the wake of the news.

Finally, the expansion of Square’s ecosystem also means that SQ will face increased competition. Square must now compete with many well-capitalized companies, including the global online-payments company PayPal Holdings (NASDAQ:PYPL), transaction-processing leader Visa (NYSE:V) and Fiserv (NASDAQ:FISV), which is shaping up to become a global- payments giant.

Therefore, the owners of SQ stock need to decide whether the company has potentially diversified way too much away from its core business of payment processing.

SQ Stock’s Short-Term Technical Chart Paints a Mixed Picture

Let us briefly remember how SQ stock price has acted over the years.

Following the initial public offering (IPO) of Square stock in late 2015, the price of SQ stock surged from $9 to an all-time high of $101.15 in October 2018, as the company became a darling of long-term investors.

SQ stock went on a big tear during the summer of 2018, and lots of euphoria became baked into the stock price. As a result, Square stock has been weak since reaching its all-time high on Oct. 1, 2018. By late December 2018, the stock was hovering around $50.

In 2019, although SQ stock is up about 30%, April and May have not been good months for the shares. The company’s weak Q2 guidance has triggered the recent volatility of Square stock.

However, in June, Square stock participated in the stock market’s rally and went up from an intraday low of $59.89 on June 3 to an intraday high of $74.55 on June 20.

From a technical perspective, I am not expecting Square stock to make another significant leg up any time soon. In the next few weeks, possibly up until its earnings report in early August, SQ stock is likely to be rangebound between $65 and $75.

SQ has strong support between $60 and $65. However, if there are any negative headlines that affect the technology sector in general or the fintech sector specifically, then Square stock may easily go below $60.

I do not expect SQ stock to reach the $100 level in the coming weeks, as the market may be starting to value the earnings growth of the stock more realistically.

The daily volatility of Square stock is high, giving it a broad trading range, so short-term traders should proceed with caution. Expect SQ to be choppy at best in the near-term.

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 the stock at this point.

Strategies for Buying SQ Stock

Square stock has fallen meaningfully in recent months. In the coming weeks, I would be a buyer of the shares of the payments company around $60 or lower, especially between $55 and $60.

Investors who already own Square stock might want to stay the course and hold their position. That said, the owners of SQ stock who are worried about short-term profit-taking may, within the parameters of their portfolio allocation and risk/return profile, consider placing a stop loss about 3%-5% below the current price point, to protect the profits they’ve made so far.

Experienced options investors may also consider using a covered call strategy with approximately a six-week time horizon. In that case, they may, for example, buy 100 shares of SQ stock around its current price of $72, and at the same time, sell, for example, a SQ Aug 16 $75 call option.

The $75-strike option offers downside protection in case of volatility and a decline of SQ stock. The strategy would also allow investors to participate in a potential price increase of Square stock. This call option will stop trading on Aug. 16 and expire on Aug. 17.

Such a covered call would provide breathing space until the markets potentially calm down. Then, after earnings season, investors can decide on the best course of action for their portfolios, with less anxiety than those who are unhedged. The owners of a growth stock like Square need to regularly assess their views based on updated earnings results and developments that affect the company and the economy.

The Bottom Line on Square Stock

The current economic and political environment in the U.S. and globally poses plenty of questions for market participants. And the owners of Square stock may have to reset their growth and share price expectations. If Square’s revenue growth decelerates, then the price of SQ stock will also go down.

I would consider buying SQ stock if  its price declines towards the $55-$60 level. I think the long-term  owners of SQ stock will be well-rewarded within three or four years as the company increases its ecosystem for small and mid-sized businesses and capitalizes on the potential of its Cash App.

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

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