Square (NYSE:SQ) stock has struggled in recent trading sessions. Weaker than expected third-quarter results, reported on Aug. 1, sent SQ stock plunging. Moreover, fears about the overall economy have put further pressure on the equity.
However, amid these shorter-term struggles, SQ has shown the potential to become the most transformative company in tech since Netflix (NASDAQ:NFLX). Netflix destroyed video stores and blunted the growth of pay-TV. In the same manner, Square’s ecosystem could present a tough challenge to both traditional and newer financial-services firms.
SQ Stock Will Probably Suffer in the Shorter Term
The inverted yield curve has stoked fears of a recession. It has also left the market with numerous stocks that look appealing in the long-run but could also hammer investors in the shorter-term. Few equities illustrate that dynamic better than SQ stock.
The day after its Aug. 1 earnings report, SQ stock fell by 14% as the company delivered what some described as “light earnings guidance” for Q3. Before the results were issued, SQ closed at $80.98 per share.
I warned investors in mid-July not to buy SQ stock until they knew that the shares could rise above the low-$80s per share level, which I believed was a potential ceiling. That upper bound held, and now SQ stock is around $65 per share.
After its recent drop, Square stock trades at a forward price-earnings (PE) ratio of about 58. From a certain point of view, it does not appear expensive. Analysts, on average, forecast profit growth for SQ of 63.8% this year and 45.5% in fiscal 2020. Numerous investors would gladly pay 58 times forward earnings for a stock that offered such growth.
However, the inverted yield curve could indicate that a recession is looming, and recessions tend to reduce investors’ tolerance for such multiples. Moreover, such conditions create concerns about profit growth . Thus far, analysts’ profit estimates for SQ continue to hold steady. However, in a recession, Square’s revenue growth would likely decline. For that reason, investors should probably not buy SQ stock now.
Square Is Set to Transform Finance as We Know It
However, investors should look to buy SQ stock as those fears begin to subside. SQ is on the path to becoming a payments ecosystem. In other words, it could become the Apple (NASDAQ:AAPL) of the payments world.
SQ began as a company that allowed any smartphone user to accept credit-card payments. The firm has ventured into multiple payments-related businesses to take advantage of the increased use of payment cards. Its innovations have presented a challenge to older payments companies such as NCR (NYSE:NCR) and Automatic Data Processing (NASDAQ:ADP).
Moreover, its innovation could reach new levels if it obtains a banking license. InvestorPlace contributor Ian Bezek correctly pointed out that becoming a bank creates a heavy regulatory burden for companies. However, as we saw when Apple entered the music business, transformative companies tend to find a way around such difficulties. Due to the size and reach of Square’s ecosystem, a successful move into banking could transform the industry.
I don’t think SQ would drive all banks out of business if it obtains a banking licence. However, it could lead investors to question the need for entities such as Citigroup (NYSE:C) or Goldman Sachs (NYSE:GS). And in such a scenario, SQ would at least force banks to transform themselves to survive.
Final Thoughts on SQ Stock
SQ stock will struggle for now, but it will eventually grow tremendously by transforming its industry. A high multiple for SQ stock, lower profits for SQ and a recession would place further pressure on Square stock in the near-term. As a result, investors should watch Square stock, but not buy it at this time.
However, the power of Square’s financial ecosystem continues to grow. That leaves companies which operate in only one part of the financial-services sector vulnerable. It could also make money-oriented IT companies or even banks as we know them obsolete. Although investors should stay out of SQ stock for now, SQ looks poised to profit from its transformation of finance as we know it.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
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