Payment processing firm Square Inc (NYSE:SQ) has had a rough week. SQ stock has fallen a staggering 20% since Monday after BITG analyst Mark Palmer downgraded the company from Neutral to sell with a price target of just $30. Palmer’s projections suggested that SQ stock had a downside of almost 40%.The news caused many investors to abandon the stock.
While some say this recent decline offers a great entry point for SQ investors, I’m still hesitant to get on board. A few weeks ago I wrote that I liked Square as a company, but that the stock was overvalued. I cautioned investors who were interested in adding square to their portfolios to wait for a pullback.
Now the question is- is this the pullback I’ve been waiting for? It’s a start, but it’s not quite enough to take SQ stock back down to earth. Palmer has a point: Square’s share price already reflects “emphatic and unimpeded growth.” However, the what Mr. Market hasn’t considered are all of the headwinds that SQ will face like competition and macroeconomic events.
The Bitcoin Angle
In Mid-November SQ stock made its way higher after reports that the firm was adding bitcoin functionality to its platform. Some Square Cash users were given the opportunity to trade Bitcoin in a new trial offering that could eventually give Square a foothold in the cryptocurrency space.
Investors cheered the move with some analysts saying that a Bitcoin trading platform could eventually add tens of millions of dollars to the firm’s revenue. The Bitcoin venture could prove to become a profitable part of Square’s business, but due to the nature of cryptocurrencies, it’s important to acknowledge the risks associated with this outcome.
Bitcoin has historically been an extremely volatile currency, so if Square does push forward to make Bitcoin trading a permanent fixture in the Square Cash app the company will be adding a lot of uncertainty to its future.
Risks Still Apply
The other issue that Palmer pointed out in his research note was the fact that taking up a stake in Bitcoin doesn’t erase the risks that Square faces: macro events and growing competition.
As Square primarily serves small- and medium-sized businesses, it’s important to note that any economic uncertainty has the potential to put a sizable dent in SQ’s bottom line.
Economic downturns tend to hit small business owners hardest. If the threat of a recession emerges, SQ shares will likely take another nosedive.
Then there’s the fact that Square has a host of competitors that could potentially disrupt the firm’s growth trajectory. PayPal Inc. (NASDAQ:PYPL) and Shopify Inc. (NYSE:SHOP) offer alternative payment processing solutions to the same target market.
Although Square was the first company to give small business owners a portable credit card processing device, it may not be able to hold its place at the top forever.
It’s not that I don’t like what Square is doing. I think the firm’s foray into Bitcoin was smart and that the company’s push further into lending could also prove very profitable. However SQ stock is massively overvalued for what it is delivering.
The company’s most recent earnings report showed troubling trends that, if they continue, could cause the stock to decline significantly. Gross payment volume fell, transaction-based revenue growth slowed and subscription and services revenue growth lagged.
That’s a problem because SQ stock is priced to deliver impressive growth, so the last thing an investor wants to see are lackluster results.
The Bottom Line
Perhaps Palmer’s $30 price target was a bit pessimistic, but I think he’s not far off SQ stock’s bottom. Now that the market has had time to digest the downgrade, Square stock appears to be back on the upswing, but it wouldn’t surprise me if this so-called “rally” turns into a bounce.
At $39 per share, Square is still too expensive to buy. The firm trades at 152 times its future earnings and has a much higher debt to equity ratio than peers like PYPL and SHOP.
I think SQ stock is finally getting a taste of gravity, but the share price is likely to make its way even lower in the months to come. If Square sheds another $5, I’d say its time to start bottom fishing.
As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities.