Square (NYSE:SQ) stock is up 40% so far in 2019, but somehow the gains seem disappointing. After all, in this market, many of its fellow players in the payments/e-commerce space have done even better than Square stock.
Indeed, tech and growth stocks on the whole have had a torrid year in this bull market. Over 300 stocks with a current market capitalization over $2 billion have outperformed SQ stock in 2019. And many are at or near all-time highs – unlike Square stock, which still sits well below October highs just over $100.
To be sure, 40% gains are nothing to sneeze at, and SQ did manage to touch an eight-month high this month before again pulling back. It’s that pullback, with earnings on the way next week, that leaves Square in an interesting spot.
Clearly, investors see some risk here and don’t apply quite the same enthusiasm to SQ that they do other tech and/or growth plays. For that to change, and for Square to bust through resistance and target a return to a triple-digit share price, next week’s report needs to be big.
A Key Q2 and an Important Q3
What’s interesting about the rally in Square stock so far this year is that earnings haven’t helped the stock’s cause. Square has continued to beat Wall Street estimates (it hasn’t missed on either line since 2016), but guidance after the last two quarters has disappointed.
Q1 earnings included soft guidance for the second quarter – and SQ fell 8% on that report. By the end of May, the stock was seemingly headed in the wrong direction.
And then market sentiment turned, and SQ stock soared. It closed the first day of trading in June below $61. Five and a half weeks later, it was at $82 – a cool 35% gain on basically no news.
But news now is on the way – and it had better be good. Square stock briefly outran Wall Street, who has an average target price at the $82 level. Guidance has been soft for two straight quarters – and investors, after an initial sell-off, have mostly forgiven the company. That’s enough for Square to join the rally – but to outperform, the company needs something to get investors excited.
What’s Next for Square Stock?
What we’ve seen in this bull market, particularly in tech, is that the market will mostly ignore valuation if the story is compelling enough. Consider SHOP, Beyond Meat (NASDAQ:BYND), Roku (NASDAQ:ROKU), and Zoom Video Communications (NASDAQ:ZM), to name just a few. If the company can deliver revenue growth, it seems that investors figure the rest will work out.
Square has a good story at the moment and good growth. It’s increasing its market share among larger businesses. Its Cash App seems to be outperforming Paypal’s Venmo. There’s a nice bull case here.
But at 70x forward earnings, even in this market, ‘nice’ isn’t good enough. And investors seem to be looking for the next growth driver for the company. It may be a move into adjacent software categories for small and medium-sized businesses.
It might be a long-awaited foray into banking. Or Square could convince investors that Cash App can be a profit center, not just a lower-margin and lower-revenue part of the larger Square ecosystem.
Again, SQ stock has dipped after each of the last two earnings reports. Simply beating consensus next week won’t be enough to move SQ higher.
The Opportunity for Square Stock
But that’s why earnings are so interesting for Square. There’s a huge opportunity here. Again, there are few growth stories in tech not trading at all-time highs. Square stock is one of them.
That can change starting next week – if Square can deliver both better-than-expected growth and convince investors that there’s another driver on the way.
At this point, valuation is expensive by traditional standards but almost cheap by the standard of tech growth stories. ZM is trading at 50x sales, and SHOP something like ~25x. SQ easily can go to 100x earnings or ~20x adjusted revenue – both of which would push the stock back over $100.
But Q2 earnings have to really sizzle, and it’s there that I’m a little skeptical. I’ve long questioned the valuation here, to begin with, and I’m not sold on the cyclical risk the company is taking on. After the last two quarters, I’m not sure Square has a beat and raise report in it.
If it does, however, investors should consider jumping on any post-earnings rally. This earnings report is coming at the right time in the right market, and if Square can deliver a big quarter, SQ stock will soar.
As of this writing, Vince Martin has no positions in any securities mentioned.