The performance of Square (NYSE:SQ) stock of late has been an exaggerated reflection of the market as a whole. Over the first nine months of 2018, amid a bull market, Square stock nearly tripled. By late December, as investors fled higher-risk plays, SQ stock had lost half of its value.
Now, in a recovering market, SQ has risen over 50% from its lows. The gains set up an intriguing — and potentially key — fourth-quarter earnings report on Wednesday afternoon. Square still isn’t even close to cheap, trading at nearly 13x 2019 consensus adjusted revenue estimates. It’s going to need a blowout quarter and a strong 2019 outlook to support the current price, let alone drive upside.
But SQ stock also is going to need a receptive market. The gains of late are a sign that investors are more comfortable with high valuations — and, given Square’s recent moves, higher risk. That’s why I called out Square earnings as one of three key reports to watch this week.
If the risk-on trade in SQ stock continues after Square earnings, that could be a sign that the market as a whole is ready to challenge 2018 highs. If not, a sell-off could be a warning sign that the 2019 tech rally is near an end.
Square Earnings Expectations
Expectations for Square earnings look aggressive but achievable. Street consensus projects adjusted revenue growth of 60.7%. That seems like a huge number — but on a year-over-year basis sales rose 68% in Q3, and over 60% the quarter before. The Street sees adjusted EPS at 14 cents, up 75% year-over-year, while suggesting essentially flat operating margins.
Estimates on both the top and bottom lines admittedly are well ahead of Square’s guidance after Q3. The company projected adjusted revenue growth of 59%, and non-GAAP EPS of 12-13 cents. That said, Square historically has guided conservatively and still beaten Street estimates. Indeed, Square revenue and earnings have come in ahead of consensus for eleven straight quarters.
Another beat does seem likely. It’s possible late-quarter stock market weakness and what appears to be a minor blip from a macro standpoint had an impact. But Square’s revenue growth has been accelerating in recent quarters – including strengthening in 2018 over 2017 — and there’s not much evidence at the moment to see that changing.
Given the gains since late December, anything less than a beat likely would lead Square stock down. And 2019 guidance may be even more important. At the moment, analysts are looking for a 43% increase in revenue and a 52% rise in earnings. It’s those expectations that have led investors to buy the dip in SQ stock. Square will have to meet those expectations – at least – on Wednesday afternoon.
Why SQ Stock Could Signal the Market’s Direction
Assuming Square earnings and guidance are good enough, the reaction to SQ stock could be telling. Even ignoring the huge valuation — Square stock trades at over 100x current 2019 consensus — there’s no shortage of risks here.
The company’s move to banking can be seen as bullish, as Luke Lango argued last month. But it also adds to the company’s macroeconomic exposure. As I pointed out last year, Square is heavily exposed to small business (also an issue for fellow high-flyer Shopify (NYSE:SHOP)). Small businesses tend to get hit first, and hardest, when the economy turns. If Square is not just serving those customers, but lending to them, the impact of a downturn on Square earnings could be even more severe.
Competition is rising as well. As Tom Taulli noted earlier this month, the merger of Fiserv (NASDAQ:FISV) and First Data (NYSE:FDC) was driven in part by a desire to better compete with Square. Big banks including Bank of America (NYSE:BAC) and JPMorgan Chase (NYSE:JPM) have partnered on Zelle, taking aim at the payments side of Square’s business.
Square admittedly has shaken off those risks — and it could continue to do so. 60%-plus growth in adjusted revenue, as seems likely in 2018, is nothing to sneeze at. Success in banking would only add to the company’s potential.
But the roller-coaster ride in SQ over the past six months has been driven largely by investors’ perceptions of those risks. The reaction to Wednesday’s report likely won’t be any different — and that could provide a valuable read-across to the rest of the market. How much risk are tech investors willing to take? Square earnings could provide an answer.
As of this writing, Vince Martin has no positions in any securities mentioned.
