Square Stock Is No Bargain Yet

The price of SQ stock has fallen recently, but its valuation remains high

Square (NYSE:SQ) has recently given back a lot of its gains from last year. After briefly topping $100 per square, SQ stock has sharply reversed. SQ stock now trades for just $65, and has failed to recover, even as the stock market has roared back from its December lows.

It’s not hard to see why SQ stock has underwhelmed so far  in 2019. The  valuation of Square stock reached outrageous levels when the shares hit $100. At that point, the market was pricing in both huge growth by SQ and a sharp upturn in its profitability. Unfortunately, Square’s first-quarter results, unveiled on May 1, did little to support either tenet of the bulls’ thesis.

Earnings Were Fine But Not Enough

Square’s Q1 results were a mixed bag. If expectations for the company had been lower, investors probably would have been fine with the results. But given the high price of SQ stock,  blowout results were needed to sustain its upward trend.

SQ reported non-GAAP earnings per share of 11 cents, which topped analysts’ consensus outlook of 8 cents. On a GAAP basis, the company continues to lose money. On the revenue side, it topped consensus expectations, but not by much. Its $489 million top line  only modestly exceeded analysts’ consensus outlook of  $480 million.

Some bulls pointed to the company’s escalating year=over-year revenue growth rate as a positive point. But, excluding the impact of Square’s recent acquisitions, its growth rate has been declining in recent quarters. Furthermore, analysts expect SQ’s growth to fall off sharply, from something in the high fifties now to closer to 40% next year. Obviously, 40% annual revenue growth is still great, but when the company is still only, at most, marginally profitable, the owners of Square stock will want its CEO, Jack Dorsey, to produce better results.

SQ Stock Still Has a High Valuation

Even after dropping 35% from its high of last year, SQ stock is really expensive compared with its peers. Square stock is trading around 7.5 times its 2018 sales and nearly 60 times analysts’ average 2019  earnings estimate.

Those numbers are much higher than the valuations of other payment tech companies. Maybe the current valuation of Square stock would make sense if SQ had recently carried out its IPO and was still early in its maturation process. But Square has been around long enough to start backing up its valuation. PayPal (NASDAQ:PYPL) stock is trading closer to six times its  sales and 30 times its  earnings.

Both WorldPay (NYSE:WP) and Global Payments (NYSE:GPN) look even cheaper than PayPal on the basis of these metrics, to say nothing of Square. The owners of Square stock have to ask themselves what makes SQ stand out from its competitors. Square dominates its niche of the smallest of businesses, but has struggled to gain traction with larger companies. As businesses’  volumes rise, Square’s fees tend to become less competitive. Jack Dorsey has to find a way to change that situation

But SQ has some other irons in the fire. Its Cash App, for example, has had a strong run, though it appears that PayPal’s Venmo is catching up. Some of Cash App’s features, such as Bitcoin trading, could cause some users’ interest in SQ to rise, but that probably won’t be enough to drive SQ stock back to its old highs. Jack Dorsey  needs something bigger, which brings us to…

Square’s Quest for a Banking License

The one thing that could really turn things around for SQ stock in a hurry would be a banking license. Square originally filed paperwork for a license in September 2017. It intended to become a Utah-based bank that would focus on small business.

However, after regulators expressed concerns about its application, SQ withdrew it. However, SQ refiled its application late last year. Why is Square so intent on obtaining a banking license? In theory, an FDIC-insured Square Bank would give SQ a large amount of disruptive power. Right now, SQ has to operate using its customers’ banks, which adds fees and friction. Square Bank would allow its small business customers to open their own accounts directly with Square, cutting out the middleman.

Obtaining a banking license  would help Square make more loans to its small-business customers. SQ arguably has better data than traditional banks, as it can see a huge portion of its customers’  transaction data in real time. Additionally, SQ could obtain payments on its loans directly from the recipients’ transactions, rather than waiting for the businesses to choose to make payments.

In theory, SQ stock should surge after it receives a banking license. But the license may never be granted. For one, the FDIC tends to be fairly cautious about granting banking licenses to more aggressive firms. I’ve been skeptical about whether Square’s small-business lending will earn high enough returns to offset the large credit risk of lending to tiny businesses. Its business model looks good during boom economic times but what happens during a recession? Perhaps regulators are wondering the same thing. Jack Dorsey will have to convince regulators that SQ’s business model will remain sound during economic downturns.

The Verdict on SQ Stock

If Square gets its banking license soon, all bets are off. But for now, SQ stock is likely to continue to struggle compared with other tech stocks.

Its last earnings report was underwhelming. With its valuation still far above that of industry rivals, Jack Dorsey needs to put up dazzling results to get its stock price moving again. Another earnings report that just barely tops expectations, let alone a miss, could send SQ stock lower in a hurry.

At the time of this writing, Ian Bezek held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.


Article printed from InvestorPlace Media, https://investorplace.com/2019/05/square-stock-is-no-bargain-yet/.

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