As far as Square Inc (NYSE:SQ) stock goes, Tuesday afternoon’s Q4 earnings report has barely registered. At the moment, Square stock has risen just 0.13% in trading Wednesday.
That’s a surprisingly small move for a highly valued growth stock which a decently sized short float and a reasonable amount of volatility in its trading, particularly over the past four months.
But the lack of movement does make some sense. On the plus side, Square posted a solid Q4, coming in modestly ahead of consensus estimates, and 2018 guidance does look strong as well. The company’s strategy of expanding its offering and becoming a “one-stop shop” for businesses certainly appears to be making progress.
At the same time, Square stock still looks awfully expensive. And there’s enough in the quarter for bears – myself included – to argue that Square’s growth potential simply isn’t quite as large as what’s already priced in.
And so there is a logic to the market’s reaction (or lack thereof) on Wednesday. Q4 earnings weren’t enough of a surprise to do much more than allow both sides to simply dig in a little further.
From a headline perspective, Square earnings were good news.
Adjusted EPS of $0.08 was a penny better than Street estimates. Adjusted revenue (which excludes transactions costs and revenue from Starbucks Corporation (NASDAQ:SBUX), a now-former Square customer) of $283 million rose 47% year-over-year, 8 points better than consensus projections.
Also, 2018 guidance looks reasonably in line. Adjusted Revenue is guided to rise 34% at the midpoint, a modest deceleration from 43% growth in 2016. Adjusted EBITDA is guided to $240-$250 million, a 73-80% increase over 2017 levels.
Q1 guidance does look a little light, particularly on the margin front, which may have raised some concerns (Square stock initially fell in after-hours trading). But CFO Sarah Friar on the Q4 call attributed Q1 guidance to increased hiring and investments that would be reaped as the year went on.
All told, it looks like a strong quarter. And many SQ bulls no doubt are wondering why Square stock hasn’t risen on the news.
The Bull Case for Square Stock
What many bulls will take away from Square’s Q4 report is further proof that the company’s strategy is working. Square no longer is just a payment company whose ‘dongle’ allows merchants to take credit card payments with their phone. Rather, it’s working toward becoming an ‘end-to-end’ provider.
Square spent a good amount of time in the Q4 shareholder letter detailing its successes on that front. After all, 36% of Adjusted Revenue in Q4 came from products launched just since 2014. The figure was 25% a year ago.
That in turn implies that those products – among them Square Capital, Caviar, Payroll, and Employee Management – saw sales climb roughly 110% Y/Y in the quarter. As such, Square’s revenue growth isn’t just based on onboarding new businesses.
It can significantly increase per-customer sales by steadily expanding its offerings, and by upselling existing customers into new products. In Q4, subscription and services-based revenue rose 96%, driven mostly by Instant Deposit, Caviar (food delivery a la Grubhub Inc (NYSE:GRUB)), and Square Capital.
The other long-term growth driver here is expanding the company’s customer base. Larger sellers showed a strong quarter, with GPV (gross payment volume) up 44%. Square is focusing on international markets in 2018. Most SQ bulls likely came out of Q4 believing that there is a long, long growth runway remaining for the Square business.
The Concerns Surrounding SQ
That’s likely the case. But the key question for Square stock is the price being paid for that growth. 2018 guidance suggests a 68x forward EV/EBITDA multiple, even at the high end of guidance. SQ trades at 13x the midpoint of adjusted revenue guidance. The forward P/E multiple is in the range of 100x.
More growth is coming, but a significant amount of growth already looks priced in. And SQ bears can point to some modest concerns around the edges. The company’s adoption of Bitcoin, which sent the stock parabolic in November, has had little impact. Commentary on the Q4 call suggests that won’t change any time soon.
EBITDA margins compressed in Q4 and are guided to do so again in Q1. The Square model looks more labor-intensive than that of Shopify Inc (NYSE:SHOP), with similar growth. And in Instant Deposit and Capital, in particular, Square is taking on lending risk to drive its revenue growth.
That strategy is working in a good economy; it may not be quite as effective should macro conditions change.
From the bearish standpoint, Q4 was good. It wasn’t close to good enough to really change the narrative here, or support a sky-high valuation.
Bottom Line on Square Stock
Competition is going to remain intense, whether it’s Grubhub in Caviar, Shopify in software, or rivals like PayPal Holdings Inc (NASDAQ:PYPL) or even NCR Corporation (NYSE:NCR). Square still has a lot of work left to do to take share and support the current price.
So far, that hasn’t been a problem. But what Q4 shows is that Square stock is going to need a few more impressive quarters, at least, to fully earn the market’s confidence.
As of this writing, Vince Martin has no positions in any securities mentioned.