If You Buy Square Inc (SQ) Stock, Pray for a Buyout

But don't hold your breath ... Square is an overvalued money-loser.

I’m not fond of Square Inc (NYSE:SQ) as far its stock goes. It does have a nifty business and product, but one needs much more than that before putting one’s hard-earned money to work as an investment.

If You Buy Square Inc (SQ) Stock, Pray for a Buyout
Source: Via Square

Financial services in general, and fintech specifically, are looking like bright places to invest for 2017.

We are moving away from the interpersonal methods of financial transactions and well on our way to doing everything electronically. Square stock, too, is on its way to providing such electronic services.

Of course, Square Register is the product we are most familiar with, but the company has plenty to offer as far as analytics, instant deposit, the ability to turn an iPad into a POS terminal, a peer-to-peer payments service, and my favorite, Square Capital, which provides merchant cash advances.

What to Like About Square Stock

Square stock has a few things going for it beyond this: Larger sellers seem to like the products, as 43% of payment volume now comes from these customers — a 600 basis point increase from the previous year. Because profit margins for larger sellers are the same as for smaller sellers, that means income per device is higher, and that means fewer devices have to be made. These economies of scale are great for a business like SQ.

Square stock can also benefit from the fact that all of Square’s products aren’t simply stand-alone items. The whole point is that the more broad a business is, the more of its services it can sign onto.

As mentioned, I love the merchant cash advance business. This is a high-margin business operating in a fragmented sector. The trick is underwriting. If Square gets a handle on this, it could make a ton of money. If not, losses could wreck the balance sheet.

SQ Stock Hurdles

There is, however, some major downside to Square stock: There’s tons of competition in payment processing, and that means having to square off (ha-ha) with the likes of PayPal Holdings Inc (NASDAQ:PYPL) and even Intuit Inc. (NASDAQ:INTU). When it comes to payment volume, Square is rather impressive in its $13 billion or so in the last quarter. But Paypal has about 6.5 times that amount.

I don’t like that SQ stock got involved with Caviar, a food delivery service. That’s “di-worse-ification,” to use Peter Lynch’s term. Management needs to be more careful in its synergistic efforts.

The biggest challenge is the same thing that faces all tech companies, even those in financial services. Things are moving very rapidly in tech, as well as in financial services. That means SQ has to invest in R&D, and sell the heck out of its products to keep pace with those big competitors.

Finally, of course, we come to the biggest hurdle I have in getting involved with Square stock. Say it with me: “the financials.” Once again, another recent initial public offering gets stickered with a ridiculous valuation

Revenue grew sharply over the past few years, up from $552 million in FY13 to $1.27 billion in FY15 (PDF). In the first nine months of FY16, revenue was also about $1.27 billion. That suggests FY16 will end with revenue of around $1.6 billion to $1.7 billion. Still, that’s a 30% growth rate, down from 50% from FY14 to FY15.

Bottom Line on SQ

Of course, expenses have also been growing, so all that lovely revenue growth has only resulted in increasing net losses.

Fiscal year 2013’s $104 million loss became $212 million in FY15, which became $236 million in the TTM. Ugh. The $42 million of free cash flow in the trailing 12 months is a good sign, though. And of course, having more than $560 million in cash with no debt is the key to SQ stock having a good runway to survive as it tries to grow.

So we are left with a company that has a market cap, net of cash, of about $4.5 billion. I think that’s insane given the increasing losses. Paypal is also insanely valued at $50 billion. That said, I would not buy Square stock at this time.

Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.


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