The recent volatility in the markets hasn’t had much of an impact on Square Inc (NYSE:SQ). The company still remains on a nice bullish path. For the year so far, Square stock is up a sizzling 43%.
As seen with the latest earnings result, the company continues to churn out impressive growth numbers, as revenues jumped by 36% to $616 million and total payment volume increased by 31% to $17.89 billion.
This was particularly impressive since the company has had to overcome the loss of a major customer, Starbucks Corporation (NASDAQ:SBUX). The coffee giant has gone on to create its own payments platform.
A key part of the success of Square has been its focus on innovation. Over the years, the company has rolled out a long list of new offerings like payroll, scheduling, gift cards, invoicing and employee management. The result is that Square has increasingly expanded its addressable market opportunity.
However, while all this is great, there are still some nagging issues. And as the valuation gets to more lofty levels, investors could be vulnerable.
So let’s take a look at some of the potential downsides with the SQ stock price:
Part of the surge in Square stock has been due to the company’s move into the bitcoin market. No doubt, for a high-tech operator, this seems like a natural. Let’s face it, the user base likely appreciates this feature.
But when it comes to crypto currencies, the volatility has been extreme. Hey, not long ago it looked like the valuations were in total free fall.
So what’s the potential harm for Square stock? Well, there is probably some speculative premium embedded in the shares (keep in mind that there are few ways to play bitcoin with equities). In other words, if there is another dramatic drop – which seems reasonable – SQ stock could feel the pressure.
According to InvestorPlace.com’s James Brumley: “Traders that jump on every trend sight-unseen can and usually do bail out just as quickly, and a huge chunk of the SQ stock rally since this time last year was bitcoin-driven. That piper is apt to be paid sooner or later.”
For now, the move into lending has proven to be a growth business. During the latest quarter, SQ lent $305 million, up 23% on a year-over-year basis.
Yet this market can be fraught with risk. Even during good economic times, online lenders have had difficulties. Just look at operators like LendingClub Corp (NYSE:LC) and On Deck Capital Inc (NYSE:ONDK).
But with interest rates rising, this could crimp some of SQ’s customers. And if the Federal Reserve makes some mistakes – which is not uncommon – there could be slower economic growth, which may make it difficult to sell loans to institutional investors.
The bull move in Square stock is not a temporary thing. Keep in mind that the shares tripled last year.
So it should be no surprise that the valuation is far from cheap, with the forward price-to-earnings multiple at 66X. This is at a stark premium to other standout tech operators like Facebook Inc (NASDAQ:FB) and Alphabet Inc (NASDAQ:GOOGL).
Besides, as Square has expanded its footprint, it has also increased the number of competitors, such as Shopify Inc (NYSE:SHOP), GrubHub Inc (NYSE:GRUB), Intuit Inc. (NASDAQ:INTU) and PayPal Holdings Inc (NASDAQ:PYPL).
And finally, with Square moving more aggressively to snag larger customers, this also poses risks. For the most part, losing out on some deals can have a material impact on revenues. And given the valuation, even a small change in the growth ramp could mean a hit to the Square stock price.
Tom Taulli is the author of High-Profit IPO Strategies, All About Commodities and All About Short Selling. Follow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.