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Square Stock is Overvalued But Could Go Higher

Thomas Niel

Square (NYSE:SQ) stock has seen a nice boost in the past two months. Trading around $60 in early June, shares in the payment processing disruptor have soared to nearly $80 a share.

square stock

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With expansion into other services, and analysts increasingly bullish on Square stock, is it time to buy?

Compared to peers, SQ appears overvalued. With high expectations of growth, Square needs to deliver in order to justify its current valuation. Does Square have upside in the short term?

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Read on to see whether SQ stock is a buy today.

Analysts Increasingly Bullish on SQ Stock

The analyst community has become increasingly bullish on Square stock. Earlier this month, Raymond James’s John Davis upgraded the stock from “Underperform” to “Market Perform.” Davis initially was bearish on the company’s valuation relative to growth expectations. He believes the company could see a boost in shares if second quarter earnings beat their guidance.

Argus analyst Stephen Biggar is also bullish on Square’s prospects. Initiating coverage earlier this month, Biggar gave the company a “Buy” rating, with a price target of $94 a share. Believing the company is positioned to capitalize on the migrations of payments to mobile applications, he is highly confident the company will meet sales growth expectations.

But with sales slowing down, are the analysts on point? Let’s take a look at Square’s first quarter earnings release, and whether results will meet guidance for the second quarter.

Square’s Past and Future Earnings

The company had a strong first quarter, with revenue up 43% year-over-year (YoY). However, YoY revenue growth is slowing down. In the fourth quarter of 2018, YoY sales growth was 51%. With this slight slowdown, investors may be concerned that the SQ growth story is fading out.

But the company has multiple avenues to expand their presence in the business services space. Thanks to the acquisition of Weebly, Square has launched Square Online Store. This platform gives Square the opportunity to seize market share from e-commerce dynamo Shopify (NYSE:SHOP).

The launch of Square Invoices is another area of growth potential. By providing payments processing, online store software, and an invoicing application, Square is now a one-stop shop for the back-end needs of small businesses.

SQ’s Cash App also has potential to disrupt much of PayPal’s (NASDAQ:PYPL) Venmo peer-to-peer payments business. PayPal is ahead in terms of monetizing Venmo. Venmo and competitor Zelle also have stronger projected usage going into 2022. To keep Cash App from turning into an “also-ran,” Square has its work cut out for them.

Square announces second quarter earnings in early August. Based on guidance provided in the first quarter press release, SQ estimates YoY sales growth of 43% for the second quarter. For the full year, the company also projects revenue growth of 43% in 2019 from 2018. This is an improvement over prior guidance, which projected 41% revenue growth for the year.

It is clear that Square’s growth is slowing down, but the business continues to compound at a rapid clip. With high growth expectations, is the company’s current valuation (high premium to peers) justified?

Square Stock Pricey Compared to Peers

Compared to its peers, Square stock is expensive. SQ trades at a Enterprise Value to EBITDA ratio (EV/EBITDA) of 1,270. Here are the EV/EBITDA ratios for Square’s competitors:

PayPal: EV/EBITDA of 48

Mastercard (NYSE:MA): EV/EBITDA of 31

Visa (NYSE:V): EV/EBITDA of 27.8

Using the EV/EBITDA metric may not be relevant in determining the company’s current valuation. Square is still in growth mode, and is years away from posting high operating margins. With substantial sales growth over the coming years, once the company becomes a cash generator, SQ stock’s valuation should begin to trade in line with PayPal. The question is whether this current potential upside is already reflected in the current market value of Square stock ($33.6 billion market capitalization).

Bottom Line: SQ Overvalued, But Could Go Higher

Square stock’s valuation is due to high investor expectations. The company’s payments processing business, sometimes referred to as “payments as a service” (PaaS) is a game changer in processing payments for small businesses. With their expansion into back-end business services (online store and invoicing software) and peer-to-peer payments, the company is becoming a stronger competitor to PayPal and Shopify.

At the current trading price (around $80 a share), SQ stock could tread water from now until the next earnings call. Failure to meet high expectations could impact the stock, causing a dip (as seen after the first quarter earnings release).

Investors looking for an opportunity may find a better entry point a few weeks down the road. Long-term, Square’s successful disruption of the payments space could make the stock a strong performer.

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

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