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Investors Need to Decide If They’re in SQ Stock for the Long Haul

SQ stock - Investors Need to Decide If They’re in SQ Stock for the Long Haul

Source: Chris Harrison via Flickr (Modified)

In retrospect, Citi Research analyst Peter Christiansen is probably wishing he’d waited a couple more days before upgrading Square (NYSE:SQ). SQ stock is down more than 14% since reporting earnings on Thursday. Third-quarter numbers that were impressive, but a Q4 outlook that fell short of expectations.

It wouldn’t be accurate to call the earnings or the estimate a full-blown disaster. Christiansen took a chance that backfired, though he’s hardly the first to do so. More important though, he may still ultimately be right, and vindicated. Square stock is falling now, but the overarching disruption story is still intact.

In other words, it wouldn’t be crazy for investors to consider stepping into Square stock here.

The Citibank Upgrade

Most investors know Square’s basic story. The company developed a small cube-shaped attachment for smartphones that turns them into credit card machines. Small businesses that weren’t big enough for payment middlemen like First Data (NYSE:FDC) and Global Payments (NYSE:GPN) are Square’s bread and butter.

Square is far more than a mere intermediary for small shops, however. It’s developed an extensive menu of soup-to-nuts solutions for small business, offering options like installment payments, e-commerce management, appointment calendars, loans and more.

It was the growth of these enterprise resource planning (ERP) tools that prompted Citi’s upgrade of SQ stock and upped the firm’s SQ stock price target from $75 to $90. Christiansen noted, “We remain convinced that Square is both a ‘new market’ and ‘lowend’ disruptor, currently growing its ownership in the micro and small business commerce enablement space — a large category that has historically been under served.”

The analyst concluded that Square’s operation, offerings and momentum would lead to annualized revenue growth of between 20% and 25% for the foreseeable future, and that EBITDA margins could expand by two to three points per year during that time. Other payment companies like Paypal (NASDAQ:PYPL) have demonstrated similar growth rates in their earlier days.

If that’s what’s in the cards though, Square doesn’t think that growth is going to start taking shape in the quarter currently underway.

Square Earnings and Outlook

For the quarter ending in September, Square turned $431 million worth of revenue into per-share earnings of 13 cents.

Both were better than expectations for income of 11 cents per share of SQ stock and sales of $413.9 million. And, perhaps more important, both were remarkably better on a year-over-year basis. The company’s reported net income of $20 million was its first-ever profit, swinging from a $16 million loss in the year-ago quarter. And the top line was up 68%. Subscription-based and service-based revenue — largely driven by Square’s ERP offerings — grew an impressive 155% year-over-year to $166 million.

Business growth might not be as robust in the fourth quarter, however. Analysts had been collectively modeling earnings of 15 cents per share of Square stock. The company, however, only offered guidance of earnings between 12 and 13 cents per share.

Square didn’t pinpoint the precise reason, or reasons, for the out-of-character profit outlook, although it’s not difficult to come up with likely explanations. Transaction-based margins have been trending lower for a couple of quarters now, and the company’s Q3 letter to shareholders plainly noted “Product development expenses were $136 million on a GAAP basis and $88 million on a non-GAAP basis in the third quarter of 2018, up 64% and 66%, respectively, year over year.”

The same letter further explained “Sales and marketing expenses were $116 million on a GAAP basis and $109 million on a non-GAAP basis in the third quarter of 2018, up 75% and 77%, respectively, year over year.”

Square may be growing, but it’s anything but cheap growth…

Bottom Line for SQ Stock

This brings us back to Citi’s bullish call. That upgrade was clearly optimistic, but it was also clearly a long-term call. Christiansen’s profit and growth model was a multi-year one that leaves room for shorter-term spending increases that chip away at EBITDA even as they support strong top line growth.

In other words, he’s not necessarily wrong, even if his timing was a bit unlucky.

His call does, however, force anybody who bought SQ stock before Thursday to decide if they’re truly in the trade for the long haul. Though Q4 may be a tad disappointing, it’s not as if spending growth is suddenly going to abate in the first quarter of the coming year. This is a conversation that could easily be recycled three months from now.

Of course, it’s not as if investors didn’t know this spending/growth, short-term/long-term showdown wasn’t coming sooner or later for Square.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities. You can follow him on Twitter, at @jbrumley.

Article printed from InvestorPlace Media, https://investorplace.com/2018/11/investors-need-to-decide-if-theyre-in-sq-stock-for-the-long-haul/.

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