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Square Stock Has Gotten Cheaper, But Not Cheap Enough

Tom Taulli

Since late July, Square (NYSE:SQ) stock has been in a funk. Consider that shares have dropped from $82 to $63 in less than 30 days. In fact, for the past 12 months, the return is a miserable loss of 20%.

Square stock intrigues longer term, but recession risks cloud the immediate picture

Source: Jonathan Weiss / Shutterstock.com

This is certainly in stark contrast to 2016 to late 2018, when SQ stock was mostly in the bull phase. Interestingly enough, mature operators like Visa (NYSE:V) and PayPal (NASDAQ:PYPL) have done much better during the past year.

Now the recent drop could easily be temporary. After all, Square remains a top player in the lucrative fintech category, which is a $100-plus trillion market opportunity.  So yes, there is lots of room for plenty of players.

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SQ has also been adept at expanding on its core payments platform. The company has expanded into areas like payroll, gift cards, loyalty programs, marketing services, e-commerce, business loans and so on. More importantly, Square has been effective in monetizing these services. During the latest quarter, subscription and service revenues spiked by 87% to $251 million.

All great, right? Yes, this is true. But I still think investors should be cautious. There are actually some nagging issues that could easily weigh on SQ stock.

The Problems with Square Stock

Take a look at the Cash App. On the face of it, it looks like a solid business, with revenues of $260 million in the quarter. But if you look deeper, you’ll notice that a hefty $135 million came from bitcoin activities.

No doubt, this segment can be highly volatile. It’s not uncommon to see major swings in the value of bitcoin. So, if there is another drop, it could make it tough for SQ to hit its growth targets.

In the meantime, the competition in the fintech market is getting more intense. Venture capitalists continue to pour billions into fast-growing startups, presenting potential challenges to Square stock.

But there has also been innovation from traditional players like Bank of America (NYSE:BAC), BB&T (NYSE:BBT), Capital One (NYSE:COF), JPMorgan (NYSE:JPM), PNC Bank (NYSE:PNC), US Bank (NYSE:USB) and Wells Fargo (NYSE:WFC).Keep in mind that these companies are the backers of Zelle, which is a successful person-to-person payments app. It has certainly benefited from the substantial financial resources, technical talent and vast distribution.

Yet I think the biggest risk factor for SQ stock is a potential recession. Granted, the U.S. economy has proven to be resilient. But there are more and more ominous signs. These include the fall off in real estate and manufacturing as well as the inversion of the yield curve.

If a recession hits – or there is a notable slowdown – the impact on Square stock could be particularly severe. The company’s main user base is small businesses, which are the most vulnerable.

Square even included this in its 10-K:

Small businesses frequently have limited budgets and limited access to capital, and they may choose to allocate their spending to items other than our financial or marketing services, especially in times of economic uncertainty or in recessions.

Bottom Line on SQ Stock

Even with the fall in SQ stock, the valuation is far from cheap. Consider that the forward price-earnings ratio is about 56 times.

True, the growth rate has continued to be strong. During the second quarter, revenue spiked by 46% to $563 million.

But again, this growth could easily decelerate if the economy stumbles. If anything, the latest fall in SQ stock is an indication of how sensitive Wall Street is. So even a small change could have an adverse impact.

So for now, it’s probably better to hold off and wait for a better valuation.

Tom Taulli is the author of the book, Artificial Intelligence Basics: A Non-Technical IntroductionFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

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