Things Will Keep Getting Worse For Square Stock

Things will go from bad to worse for Square's stock

Investors have dumped shares of Square (NYSE:SQ) since the last earnings report. And it’s only going to get worse. SQ stock is in a sharp downward trend that shows no sign of letting up. All told, there’s a good case for Square stock heading back to the lows around $50 a share.

This Market Overreaction Is Just One More Reason to Buy Square Stock
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The company’s last earnings report was far from good. The company offered specific developments, such as the sale of Caviar to Doordash for modest consideration that really hurt Square’s long-term growth narrative. And there’s a lot more to be nervous about with SQ stock right now. Let’s dive into the reasons why SQ stock is still a sell right now.

Is Cash App Really Doing That Great?

Cash App pulled in $260 million in revenue in last quarter with a rapid growth rate. At first blush, that sounds fantastic. But there’s less here than meets the eye.

For one thing, right around half of that revenue came from Bitcoin transactions. Get rid of that, and Cash App’s revenues are down to $135 million for the quarter. Who knows where Bitcoin and crypto will go from here. Maybe the recent recovery is real. Maybe not. Anyone that bet on bitcoin or crypto stocks in late 2017 got clobbered the next year. Don’t bet the farm on SQ stock hoping Bitcoin revenues continue to surge.

Meanwhile, the more durable main source of Cash App revenue appears to be its instant deposit feature. This, like Paypal (NASDAQ:PYPL), allows vendors to access their cash instantly for a small fee. However, this is quite uneconomic for larger users and thus is unlikely to be a major revenue growth stream forever. Also, the Fed’s new real-time payment system may reduce the need for Square’s service here.

A Bank License May Not Be So Great

There’s also the matter that Square is still trying to get a banking license. It was previously unsuccessful but has made another attempt at regulatory approval.

SQ stock bulls point to a banking license as a major catalyst that could shoot the stock back up toward last year’s highs. In theory, Square as a bank could add a lot of value for its customers.

But taking on the role of a bank adds a lot of headaches and red tape as well. You have to worry about compliance, capital reserves, and all the other stresses of post-financial crisis era banking. In addition, customers that currently pay for services such as instant deposit are going to expect a lower fee experience if they bank with Square as well.

On top of all that, are the people bullish on Square as a bank looking at the same financial markets that the rest of us are?

The big banking shares like Goldman Sachs (NYSE:GS) and Wells Fargo (NYSE:WFC) are performing quite poorly in the market this year. Goldman Sachs, in particular, with all its customer-focused new innovations such as the Apple Card is getting no respect at all. If the market is petrified of interest rates and recession risk for banks, why is it going to give Square stock huge credit for entering this out-of-favor industry?

Square Stock Is Really Expensive

A big issue for SQ stock going forward is that the company still makes hardly any money. In the past, this was easier to explain because the company was purportedly investing heavily in loss-making growth operations like Caviar that would pay off in spades later. But Caviar didn’t. And with Square shedding its money-losing operations, in theory, it should look a lot more profitable going forward.

And yet, it’s not. Adjusted EBITDA is likely to come in around $400 million for this year. Given Square’s market cap, this means investors are paying in the neighborhood of 70x EBITDA for this business. That’s absolutely absurd. You can justify 20 or 25x for a fast-growing tech company with good cash flows. Square isn’t that fast-growing, especially without Caviar, and its operational profile isn’t that amazing either.

In fact, Square should probably trade at a discount to tech peers due to the credit exposure and recession risk (since its client base is primarily smaller businesses). Instead, the market is pricing SQ stock as though it were as good as the hottest of the cloud software companies. Unless Square’s business performs exceptionally well going forward, people are going to get burned here in a major way.

SQ Stock Verdict

I know Square stock is down a lot, and you might want to buy the dip. But there are better tech plays at this time. SQ stock was profoundly overvalued before; a 25% drop has hardly fixed the valuation issue. In addition to the above concerns, consider analyst sentiment.

You have various analysts with hold ratings or tepid sorts of recommendations for SQ stock with price targets in the $80s or higher. With the stock now under $65, analysts will need to lower their targets, particularly with growth avenues such as Caviar disappearing. I wouldn’t be surprised if analyst downgrades and price targets help push Square stock back down to 52-week lows around the $50 mark.

At the time of this writing, Ian Bezek owned GS and WFC stock. You can reach him on Twitter at @irbezek.

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