To be honest, it looked to me like Square Inc (NYSE:SQ) was set up to fail ahead of Square earnings on Wednesday afternoon. SQ stock had almost doubled year-to-date.
Sentiment toward the payments industry was clearly bullish. SQ stock wasn’t alone in soaring. Stocks like Visa Inc (NYSE:V), Mastercard Inc (NYSE:MA), PayPal Holdings Inc (NASDAQ:PYPL), and Shopify Inc (US) (NYSE:SHOP) similarly have posted sharp gains in 2017.
It looked like Square needed to post an earnings beat — or suffer the consequences.
Square earnings did lead to the much-needed win … but it’s perhaps a sign of how much optimism was baked into SQ stock that it’s up less than 1% in after-hours trading. Square posted a surprise adjusted profit, and raised full-year guidance in the process. So far, investors have only shrugged.
SQ stock still looks awful pricey, and I can’t help but agree with InvestorPlace columnist Bret Kenwell, who argued ahead of earnings that the stock needed a pullback. But growth stock investors will enjoy Square earnings, and the likelihood of a takeout by a larger payments player only seems to grow with each strong quarter from Square.
Square Earnings for Q2
It certainly looks like good news all around for Square earnings. Revenue of $552 million grew 26% year-over-year, and was nicely ahead of consensus estimates for $536 million. Square earnings were negative on a GAAP basis, but adjusted EPS of 7 cents handily beat Street expectations for a loss of 5 cents per share.
Full-year guidance was raised as well — though perhaps not quite to the level SQ bulls might have liked. Adjusted revenue — which excludes revenue from former customer Starbucks Corporation (NASDAQ:SBUX) — increased about $27.5 million at the midpoint.
But much of that increase simply is coming from Q2 outperformance, not higher expectations for the second half. Square, at the least, expects to be firmly profitable on an adjusted basis, with guidance of 21 cents to 23 cents in adjusted EPS well ahead of Street estimates for a full-year loss.
Below the headlines, the news was solid as well. GPV (gross payment volume) rose 32%, as more transactions are managed through the Square platform. The company continued to make progress with larger sellers (over $500,000 in annual payments), whose penetration rose to 19%, against just 14% the year before. Those sellers do pay lower rates — but they also provide a more stable base for Square earnings growth.
Square Capital loan volume increased 68%, as that important initiative continues to gain steam. Square is even rolling out an installment payment program for its sellers, an intriguing way to goose growth.
There’s a lot to like in Square earnings. The only question is how much of that is baked into SQ stock.
SQ Stock Still Looks Pricey
Given the near-doubling in SQ stock YTD, I’m not sure Square earnings really change the valuation issue here all that much. Even backing out over $1 billion in cash on the balance sheet, Square still trades at about 80 times Adjusted Ebitda guidance and over 100 times per-share earnings.
Obviously, adjusted revenue growth of 35% can bring those multiples down, and quickly. And with SQ stock at about 10x adjusted revenue, it still trades to a discount relative to SHOP. That stock, incredibly, trades at about 15x its revenue. M&A rumors will continue to swirl, with PayPal an oft-cited potential acquirer. But the price paid at this point would have to be enormous to justify a premium to the already-rich valuation of SQ stock.
Square is on the right track, to be sure. It has a decent chance of surpassing Twitter Inc (NYSE:TWTR) in valuation over the next few years. That would make Square the more valuable of CEO Jack Dorsey’s two companies.
But as good as Q2 was, it sure looks like the Square earnings beat was priced in to some extent. And at least in after-hours trading, the market seems to agree.
As of this writing, Vince Martin has no positions in any securities mentioned.
