A little less than a month ago, I suggested new entries into Square Inc (NYSE:SQ) were a bad idea. While the company is actually doing quite well, Square stock itself appeared to be toying with a sizable pullback. Then just a few days later, proving that nothing is ever etched in stone, Square stock also flight. It rallied more than 20% from its 2017 year-end price. It was a nice boost, driven by nothing in particular.
Oh, the calendar helped, to be sure, as did the broad market’s bullish tide. Cryptocurrency mania was also rekindled in a big way so far this year, and while Square’s involvement in the bitcoin movement is a modest one (at best) thus far, that’s not staved off a willingness from traders to buy into anything related to blockchain technologies. Case in point: When a Long Island company that previously sold iced tea changed its focus and its name to Long Blockchain Corp (NASDAQ:LTEA), a triple-digit gain ensued.
Still, I’m going to stick to my original thesis and reiterate the idea that Square stock is going to have to move much lower before it moves meaningfully higher again.
Make no mistake though — this company’s prospects remain incredible, and any decent dip is a buying opportunity.
Enviable Growth for SQ Stock
You know the company, even if you think you don’t. The little white block attached to smartphones that turns them into credit card acceptance devices? Square makes them, and manages the service that powers them, catering to small merchants that outfits like Visa Inc (NYSE:V) or First Data Corp (NYSE:FDC) largely ignore.
That’s not all the company does, however. It’s wading deeper into financial waters, and has designs to become a top lender to the small-borrower market that even most community banks have ignored. It’s starting with its most obvious potential lending customers … users of its Square payment devices, which are small businesses that likely need short-term cash flow help.
The end result is trailing and projected revenue and profit-growth that most any company would envy. The pros are calling for a 32% improvement in revenue this year, which should widen per share profits for Square stock from 2017’s projected 26 cents to 45 cents in 2018. The picture looks just as rosy further down the road, particularly if the brewing economic boom sparks the creation of new small businesses.
SQ Stock’s Potential Pitfalls
While the trend has been decidedly bullish this year, Square stock remains a little too vulnerable to profit-taking for my liking.
One of the potential pitfalls is the stock’s valuation.
Not that traders haven’t made crazier, less-fundamentally-sound trades, but the forward-looking P/E of 93.6 still pushes the limits of what is palatable. The recent rise against the odds reflects the market’s opinion and feelings of January’s splashy headlines, but such a frothy valuation may be tough (if not impossible) to sustain once the euphoria fades.
And it always fades.
Even without the sky-high valuation though, SQ shares themselves are back to the dangerous over-bought situation they were in as of late November — before the sizeable pullback. Square stock is up more than 180% for the past 12 months, which is a stretch by any standard regardless of underlying value. And, as was noted, Square stock already has a valuation problem.
Regardless, until shares break under the 100-day moving average line (gray) at $34.70 and break below the December low around the same level, the stock’s not in any real danger. Should those floors break though, the selling avalanche could develop in a hurry.
Just don’t forget to step into the stock if and when that finally happens.
Bottom Line for SQ Stock
And that’s the crux of what any wise investor needs to digest about Square right now: Timing is the key.
Giving credit where it’s due, Buckingham Research Group analyst Chris Brendler hit the nail on the head earlier this year with his upgrade of SQ stock. Brandler is bullish on Square right now. But he also concedes that the valuation is “challenging.” More than anything though, he acknowledges that the near-term results and action are tricky to handicap, even if the long-term picture looks great. He wrote:
“While this longer-term view greatly increases the uncertainty, we believe the potential variances are weighted to the upside with such strong underlying momentum plus material upside from potential M&A and int’l expansion. Combined with continued EPS momentum in 2018, we expect the stock to deliver on high expectations and justify its premium valuation.”
Square stock can still justify that premium valuation even if it takes a sizable hit in the meantime. And that seems to be what’s in the cards. It’s not likely the market will be able to sustain this valuation waiting on 2020’s results. Those are the ones Brandler used to establish has a price target of $42.
In fact, Square stock hit that target on Thursday. That may be enough to get the opinion pendulum swinging the other way again for Square stock, finally creating the much-needed pullback.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.
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