I like Square Inc (NYSE:SQ) as a business. SQ stock? Not so much. And, admittedly, that’s been the wrong call so far. SQ stock gained a whopping 147% in 2017, even with a year-end pullback. It’s added another 16% just in the first three weeks of 2018.
All-time highs near $50, reached amid a somewhat silly Bitcoin-related bull run, look potentially achievable this year. And the payment processing company no doubt has years of growth ahead of it, thanks to its increasing penetration of small and mid-sized businesses.
There’s good news here. I understand why investors would want to buy Square stock. But at this price, the bull case is increasingly tough to make. Square, which isn’t profitable without excluding share-based compensation, now is worth over $14 billion.
Late last year, its market capitalization briefly exceeded that of CEO Jack Dorsey’s other, better-known, company: Twitter Inc (NYSE:TWTR).
The optimism reflected in the SQ stock price simply seems a bit much. And that optimism reached a crescendo Friday, as Square stock gained another 5%+ on the back of a bullish analyst note.
Just this month, analysts have compared the company to Netflix, Inc. (NASDAQ:NFLX), Amazon.com, Inc. (NASDAQ:AMZN), and Alphabet Inc (NASDAQ:GOOGL). If there ever was a sign that SQ bulls are getting ahead of themselves, this seems to be it.
SQ Stock the Next Google?
On Friday, Nomura analyst Dan Dolev lifted his price target on SQ stock to $64 from $48. The analyst wrote that Square’s growth was such that “conventional valuation methodologies” don’t properly capture the true worth of Square stock. Rather, like early-days Amazon or Google, investors need to take a more expansive view.
Dolev’s comparison to Amazon and Google itself is somewhat fair, in the sense that Square will have opportunities beyond simple payment processing as it grows. Just as Amazon no longer is just an online book seller, and Google no longer just a search engine, Square’s business no doubt will expand.
But expanding the business doesn’t guarantee winning in those new markets. Amazon had a first-mover advantage in many adjacent markets, notably e-commerce and its cloud services business, now worth at least $150 billion. Alphabet, meanwhile, remains concerningly reliant on advertising revenue, despite its diversification efforts.
And in the near-term, any analyst or investor ignoring “conventional” valuation methods essentially is saying that price doesn’t matter. That’s never the case – and those valuation methods show a significantly overvalued stock. Square’s EBITDA this year will be negative, when backing out the issuance of Square stock to employees.
Yes, growth is coming for years. But success isn’t guaranteed in the crowded payment space, let alone in areas like payroll and human resources where well-funded giants already roam the markets. PayPal Holdings Inc (NASDAQ:PYPL), Workday Inc (NASDAQ:WDAY), Shopify Inc (US) (NYSE:SHOP), and many others will be fighting for the same turf.
The easier path that Amazon had simply isn’t open to Square. As such, valuing Square like early-days Amazon is a good way to derive an overly optimistic valuation – which is what $48, let alone $64, looks like from here.
Or the Next Netflix?
Earlier this month, Buckingham analyst Chris Brendler compared Square to Netflix. Here, too, the comparison makes more sense than it might first appear.
Obviously, Square isn’t a streaming media play. It isn’t even a direct consumer play. But Brendler’s point is that Square has an international opportunity much like that of Netflix, whose international subscribers now outnumber their domestic counterparts.
And that’s true. But it’s an opportunity that is a long ways off. Through the first nine months of 2017, Square’s international revenue was barely 4% of its total, just $64 million. Again, this is a $14 billion company. The figure has grown 40% year-over-year. But even at that rate, it would take five full years for Square to get international revenue to the $500 million mark.
Even with Brendler approvingly citing that international opportunity, he assigned a price target to Square stock of just $42. That’s below the current price on Friday, barely two weeks later. Even bullish analysts are having a hard time valuing Square stock for any upside, unless they choose to compare Square to the most successful companies of all-time.
SQ Stock Still Looks Far Too Expensive
Admittedly, I’ve been wrong on SQ for most of the past eight months. The stock has run much further, much faster, than I thought possible. And I do understand the optimism toward the space, one reason I’m still bullish on similarly high-valued SHOP.
But valuation matters. And when bulls are looking for valuation methods that aren’t “conventional” to support upside, a top very well could be near. I’m not interested in shorting SQ stock, but if I owned, I’d be heading for the exits right about now.
As of this writing, Vince Martin has no positions in any securities mentioned.
