If Square Stock Doesn’t Top Out Soon, It Is Time to Worry


Square stock - If Square Stock Doesn’t Top Out Soon, It Is Time to Worry

Source: Via Square

In this market, particularly in tech, arguing that a growth stock is “too expensive” is a good way to look foolish. That’s been true for Square Inc (NYSE:SQ), being put the company of stocks like Amazon.com (NASDAQ:AMZN) and Netflix (NASDAQ:NFLX). Square stock now has more than doubled in 2018 and nearly has tripled over the past year.

And indeed, I’ve looked more than a bit foolish when it comes to Square stock, most recently in early March. But what’s interesting is that it’s not as if Square’s own performance really has been that impressive of late, at least relative to expectations.

Both Q1 and Q2 results were strong and its growth is impressive, particularly the 87% increase in adjusted EBITDA in the most recent quarter. But both quarters only narrowly beat Street consensus and full-year profit guidance hasn’t moved since the company’s fourth quarter release on February 27.

Yet since that date, Square has risen some 57% – with most of that gain coming from multiple expansion. SQ now trades at a whopping 116x the high end of 2018 Adjusted EBITDA guidance, 9x net revenue, and 19x adjusted revenue. The obvious question at this point is how much higher those multiples can go?

The Case for Square Stock

The core reason the multiples assigned to Square have expanded is that investors are increasingly confident in the long-term outlook for Square. And while I’m not entirely sold on the current valuation, I do understand that optimism.

As I wrote back in April, Square is a stock that could be the next Amazon, using its core payment offering as merely an initial step in offering a range of services from payroll to back-office processing to human resources.

And on that front, there has been some good news for Square, at least from a bullish standpoint. The company is moving into credit, with plans to file for an industrial loan company charter. Through a partnership with eBay (NASDAQ:EBAY), Square will provide loans to small businesses.

Meanwhile, the core business is growing impressively and has plenty of room to continue that growth. The company can move toward larger sellers in addition to continued penetration among small- and medium-sized customers. And the decision by Snap (NYSE:SNAP) to shut down its Snapcash provides one less competitor on that front.

It is too simplistic to argue that Square shouldn’t have gained simply because full-year expectations haven’t moved (and it’s worth noting that revenue projections have increased). There’s a lot to like when it comes to Square as a business, and plenty of reasons for the optimism toward Square stock.

Valuation Concerns

Still, it’s worth wondering at what point the rally has to end. Square now is worth nearly $30 billion. It trades at 19x adjusted revenue; PayPal Holdings (NASDAQ:PYPL) trades at 7x.  The 100x+ adjusted EBITDA multiple is one of the highest in the entire market.

Square is growing quickly, but it takes an awful lot to grow into that multiple. Assume the company can grow revenue 30% for a decade (something of which very few companies are capable).

Give Square credit for 30% net margins at the end of the decade, one of the highest levels in the market. And assign SQ an out-year multiple of 30x, a number which assumes still more growth ahead. Those optimistic assumptions, discounted back at 8%, still value SQ stock at about $88.

Admittedly, that’s 20% upside but in a hugely optimistic scenario. It’s possible Square could be taken over in the meantime but could an acquirer justify a premium to 100x+ EBITDA, or even 60x+ assuming strong growth in 2019?

In the meantime, moving into lending isn’t a risk-free shift and generally is a business that leads to lower multiples, as a Street analyst pointed out earlier this year.

That’s why Square stock has once again outrun Street target prices  above $68, about 8% below current levels. And it’s why, once again, I’m skeptical that SQ can rally much further. And yet, I have said the same thing for a while. Perhaps SQ will continue trading on an attractive long-term story with investors figuring the numbers will take care of themselves somehow.

As of this writing, Vince Martin has no positions in any securities mentioned.

After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.

Article printed from InvestorPlace Media, https://investorplace.com/2018/08/square-stock-time-worry/.

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