Square (NYSE:SQ) continues its march higher. Product releases and moves into other areas to bolster the San Francisco-based credit card processing business. Square also got an analyst upgrade, that took Square stock to elevated levels. Given the stock’s premium compared to peers in the same space, I would recommend staying away from Square stock for the foreseeable future.
Square Thrives Small
Square brought to the market an ability for the average American to process credit cards through their smartphone. This has allowed individuals or street vendors the ability to offer the same payment options as the largest retailers. Peers have begun to copy this phone-based credit card processing, and Square has proven it can thrive against larger, better-funded rivals.
Square also benefits from an unspoken consumer preference. Software companies trusted for other applications struggle to also be trusted with money. In the 1990s, Microsoft (NASDAQ:MSFT) failed to outcompete the much smaller Intuit (NASDAQ:INTU) despite its vast resources. Amazon (NASDAQ:AMZN) failed to displace Square in a similar situation in this decade.
Attempts to acquire financial tech companies have also not lasted. In the 2000s, eBay (NASDAQ:EBAY) acquired PayPal (NASDAQ:PYPL). However, in 2015, eBay’s board determined that both companies would grow faster if they separated. It subsequently spun off the online payments company.
My colleague Vince Martin proposed the possibility of a credit card processor such as Visa (NYSE:V) or Mastercard (NYSE:MA) acquiring Square. However, I believe the historical precedent from eBay and PayPal indicates such a merger would fail. Also, it would likely not occur in the first place. If the Justice Department did not block such an alliance, market realities probably would.
Square’s PE Needs Another Look
The reality facing prospective buyers relates to its valuation. Assuming the consensus 2018 profit forecast of 46 cents per share holds, the forward price-to-earnings (PE) ratio of Square will exceed 150. Profit growth remains high. However, I do not see enough growth to justify such a valuation.
Not all agree. Credit Suisse (NYSE:CS) just upgraded Square stock from “neutral” to “outperform.” They placed an $81 per share price target on the equity. This would represent about a 15% increase from the current trading price of around $70 per share.
I have to admit that such a move remains possible. Still, I’m bearish on Square from a valuation perspective. This PE prices SQ stock for perfection. While I think Square is a great company that will do well for decades to come, I would caution against paying such a price.
PayPal directly competes with Square in the core smartphone-based payment space. It holds a forward PE of just over 37 currently.
Moreover, competitive threats from other firms loom large. Intuit, which processes credit cards through its QuickBooks software, supports a forward multiple of about 33.5.
Visa’s leadership in credit cards takes its PE to just under 27. As phone-based credit card processing goes from unique to ubiquitous, Square’s product offerings will likely struggle to stand out.
The Bottom Line on Square Stock
Given the premium over the stock of its peers and the increasing difficulty to stand out, I would recommend staying away from Square stock for now. SQ stock brought a huge benefit to small business by enabling almost anyone, anywhere to process credit cards.
However, competitors have entered its space, and this has compromised its ability to stand out among peers. Moreover, the company’s popularity has taken the forward PE above 150.
Despite its high profit growth, it will likely fail at supporting such a multiple long term. Square is a great company and could become a good investment at a lower valuation. Still, at this price, investors should stay away for the time being.
As of this writing, Will Healy did not hold a position in any of the aforementioned stocks. You can follow Will on Twitter at @HealyWriting.
