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Square Stock Has Been Under Pressure, May Retest $50

Tezcan Gecgil

Over the past decade, Square (NYSE:SQ) has become a dominant player in the mobile payments and financing sphere. And the SQ stock price since 2015 has reflected the company’s exponential growth.

Twitter's Been Hot, but Square Stock Still Is the Better Buy

Source: IgorGolovniov / Shutterstock.com

However, Square stock is off its recent highs, as the shares got penalized following its second-quarter earnings report in August. Year-to-date, the SQ stock price is basically flat. Now may be a good time to ask why Square shares have been falling and what we can expect in the final quarter of 2019.

I believe that the owners of Square stock may have to reset their growth and share price expectations. In the coming weeks, I’d be a buyer below $55, especially if the price approaches or even goes below $50. Here are the must-know fundamental metric and price levels for SQ stock.

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Square Stock’s Q3 Guidance Failed to Impress

Square was co-founded in February 2009 by Jack Dorsey, who is also the CEO of Twitter (NYSE:TWTR). Its payments processing business, also referred to as “payments as a service,” has been a game changer in serving small businesses. To the delight of early investors, this innovative financial services company has expanded quickly and become a disruptor.

SQ stock reported Q2 earnings on Aug. 1 after market close. Notably, the payment-solutions company posted better-than-expected earnings and revenues. Its total net revenue increased 44% year-over-year to $1.17 billion.

And on an adjusted basis, earnings were 21 cents per share, beating Wall Street’s expectation of 17 cents per share. A year ago in Q3, Square stock’s adjusted earnings per share came in at 13 cents.

Square’s subscription and services-based revenue also increased 87% to $251 million. Gross payment volume of $26.8 billion increased from $21.4 billion year-over-year. This growth has been driven by its Cash App, Square Capital and Instant Deposit. Analysts were especially impressed with Cash App — quarterly revenue came at $135 million.

The quarterly report once again confirmed that Square stock is a high-growth equity. Such shares in general are far more volatile than market indices or mature companies. Whenever investors feel growth expectations need to be toned down, they sell the stock first and ask questions later.

Investors were especially concerned by the company’s lower-than-expected Q3 guidance. Its Q3 adjusted-EPS guidance of 18 cents to 20 cents trailed the average estimate of 22 cents. Square management now expects Q3 adjusted revenue to be between $590 million and $600 million as opposed to the consensus of $599 million.

Square stock’s losses on the bottom line are also projected to be higher than expected. And many shareholders have likely felt that for the rest of the year, SQ stock may face a rising tide.

Where SQ Stock’s Price Is Now

The U.S. stock market has had several big winners in the past year. However, Square stock has not been one of them. Over the past 12 months, SQ shares are down about 36%.

Let us briefly remember how the Square stock price has acted over the years to have a better view on what to expect in the coming weeks.

Following SQ stock’s IPO in late 2015, its price surged from $9 to an all-time high of $101.15 in October 2018, as the company became a darling of long-term investors.

SQ stock went on a big tear during the summer of 2018, baking in plenty of euphoria. As a result, shares have been weak since reaching its all-time high on Oct. 1, 2018. By late December 2018, SQ was hovering around $50.

After a highly volatile first half of 2019, August has not been a good month for Square shares either. That’s of course due to the weak Q3 guidance which has underwhelmed investors.

On earnings day, Square stock closed at $80.98. The next morning, SQ shares gapped down to open at $70.80. Now the shares are hovering around $58.

From a technical perspective, I’m not expecting Square stock to make another significant leg up any time soon. In the next few weeks, shares are likely to be rangebound between $50 and $55.

Plus, based on options trading, many bets are being placed that Square shares will see $50 before too long.

The upside momentum can build up only when long-term investors feel that the SQ stock price justifies the future growth expectations. Consequently, investors need to be careful about chasing Square stock at this point.


Square Stock Is Still Richly Valued

Although the decline in Square’s stock has improved the valuation, the shares are still richly valued.

While SQ currently enjoys a head start in serving small businesses, Wall Street has questions about whether it can maintain that growth. If the U.S. economy slows, Square’s growth may start to decelerate rather quickly.

Furthermore, Square is not yet profitable. Its net loss was $7 million in Q2, compared to a net loss of $6 million in the year-ago quarter. The company has reported net losses in five of the last six quarters.  And unless it increases its revenue, Wall Street may take the high valuation of SQ stock down even further.

The expansion of Square’s ecosystem also means that SQ is facing increased competition. Square must now compete with many well-capitalized companies, including the global online-payments company PayPal (NASDAQ:PYPL), transaction-processing leader Visa (NYSE:V) and Fiserv  (NASDAQ:FISV), which is shaping up to become a global-payments giant.

Most SQ stock holders are well aware that the shares do not trade at bargain-bin valuation ratios, especially compared to its competitors. For example, SQ’s forward price-to-earnings ratio is over 50. On the other hand forward P/E ratios for PYPL, V and FISV stocks are about 30, 28 and 26 respectively.

Similarly Square stock’s current price-to-sales ratio is over 6.3x. Companies generate revenue from the sale of goods and services. Analysts prefer a low P/S multiple, ideally below 1x. However, a P/S number between 1x and 2x is more common. To put the metric into perspective, S&P 500’s average price-to-sales ratio is 2.1x.

In short, I do not think there is much room for Square stock’s valuation to head higher in the final quarter of the year. Sooner or later, SQ stock’s valuation and revenue growth will be more in balance.

Should You Buy SQ Stock?

The fintech app revolution is quickly changing the way traditional banks, credit card issuers and mobile-payments companies work with businesses as well as with their retail customers. Therefore, over the long term, I would not bet against SQ stock. In the short term, though, stakeholders shouldn’t expect smooth sailing.

I believe the volatility and selling in the markets will continue in September as well as in early October. Like many momentum plays, SQ stock is likely to be a battleground between two camps: investors and traders.

Square is a high beta stock at 3.3. The stock market has a beta of 1.0. SQ stock’s beta measures its volatility in relation to the market. In other words, Square stock rises more than the market in bullish conditions and decreases more when markets are falling. Short-term traders should exercise caution if they want to participate in SQ stock’s wide daily swings.

It is likely that Square shares will fall toward $50, where I’d expect SQ stock to start to stabilize and then trade sideways until the next earnings release, expected in early November.

Indeed, Square stock may become one of the first momentum stocks to test the lows it saw between $49-$50 in December 2018, hence making a double bottom in technical charts. Only then the twice-touched low may become a more reliable long-term support level.

In other words, I’d not rush to buy Square stock yet. However, I’d get ready to initiate a position as the price declines further, toward $50.

At the time of writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.

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