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Square Stock Is Sounding the Alarm on a Souring U.S. Economy

Dana Blankenhorn

Since delivering what you can only call a bad earnings report on Aug. 1, Square (NYSE:SQ) has fallen and it can’t get up. Shares that traded at $81 before the report came opened Oct. 24 just under $60.

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What makes this so surprising is that the Aug. 1 report beat consensus estimates — and management was guiding for more of the same for its next report on Nov. 6. Since the second-quarter report analysts have also raised their earnings estimates, and the “whisper number” they’re hoping for is even better.

It seems analysts really haven’t soured on Square. They’ve soured on the economy.

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The Problem

Square found a niche in the payments business by giving the tiniest businesses a way to take credit cards.

It did so with card-swiping machines that plugged directly into a smartphone and came with a simple price structure of 2.75% per transaction. Then Square began layering other services on top of it, including loans, based on the merchants’ transaction volumes.

For the first three years after going public, this business model made Square an attractive growth stock. SQ stock closed on Sept. 24, 2018 at $99. But now analysts see the downside to this. Square’s pricing keeps it from going after bigger accounts.

So Square is doing something about it. It’s changing its pricing. Starting Nov. 1, merchants will pay 2.6% along with a 10 cent “swipe fee” instead of the former 2.75% rate. Instead of paying 2.75%,

This may let Square go after fancy restaurants, where tickets average $100 or more. But it hurts small coffee shops and the other “micro-merchants” Square was built on. The rest of the industry has also been consolidating to deal with Square.

Processors have been buying software companies and merging with one another to create scale and lower prices. Merchant processors have been buying card processors, and these have become the new shiny objects of analysts. Visa (NYSE:V) and Mastercard (NYSE:MA) shares remain strong.


Can Square Bounce Back?

The problems with SQ stock are all in the stock market. Square hasn’t changed. Analysts’ views of it changed.

They realized that Square is a very expensive stock. Even on Oct. 24 you’re paying nearly 8 times revenue for a company that usually loses money. That’s not out of line for the industry. Visa now trades at over 17 times revenue. So does Mastercard. But those companies have earnings and dividends. Square doesn’t.

The fall of SQ stock has some analysts pressing the buy button. Wells Fargo (NYSE:WFC) upgraded the stock in September. The last few times Square hit a dreaded “death cross,” the average price over a quarter falling below that for a year, it quickly bounced back.

Square shares did rise after the bullish calls, to over $64. But a month later they trade at nearly the same price they were at before the “buy” signal went out. So much for technicians and “oversold” indicators.

The Bottom Line on SQ Stock

Square is flashing a signal about the economy. It’s not a good one.

The stock has become much more sensitive to economic moods and the current mood is souring.

The price hike won’t be reflected in the third-quarter results. They could disappoint again.

Management seems aware of the gathering gloom. Cash on hand has been increasing this year and stood at over $1.6 billion in June. There has been a focus on operating cash flow, which has also been increasing. Over the longer run Square should keep growing and could even be bought in the wake of a recession.

But now is not the time to buy Square. Now may not be the time to buy anything.

Dana Blankenhorn is a financial and technology journalist. He is the author of the historical mystery romance The Reluctant Detective Travels in Time available now at the Amazon Kindle store. Write him at danablankenhorn@gmail.com or follow him on Twitter at @danablankenhorn. As of this writing he owned no shares in companies mentioned in this story.

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