Square Stock Is Overvalued for a Growth Company Doing Less Growing

Square’s decelerating sales growth raises doubt about its valuation

Square (NYSE:SQ) stock has fallen 26% from its recent peak in July 2019 as the concerns about its disappointing earnings and valuation have increased. In fact year-to-date, SQ stock, up just 4.1%, has underperformed the S&P 500 — which is up 17.7%.

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SQ stock trades at over 52 times forward earnings and the 61 times its enterprise value (EV) to EBITDA ratio, according to Yahoo Finance. This is outrageously high for a company that posted tepid sales and earnings growth for Q2.

Decelerating Growth

Square reported adjusted Q2 sales growth of just 15% over Q1. Normally for any other competitor in the payment space this would be considered a great achievement. But for SQ, whose stock trades at over 6.6 EV-to-sales this sales growth is not adequate to justify that high valuation.

More importantly, SQ’s year-over-year (YoY) growth rate for adjusted revenue is slowing. For example, the Q2 YoY growth rate was 46%, which is 13 percentage points below the Q1 YoY growth rate of 59%. The YoY Q1 growth rate was 6 percentage points below the Q4 growth rate…which was itself 4 percentage points below that of Q3. You see the trend.

Moreover, although SQ’s adjusted EBITDA cash flow was $105 million in Q2, this is not enough to justify its $25.8 billion market value. The annualized EV/EBITDA ratio is over 61x. This is simply too high a valuation, especially when competitors like Fiserv (NASDAQ:FISV) trade for 25x and PayPal (NASDAQ:PYPL) at 39x.

Signs of Increasing Competition

One of the problems that Square has is that most of its business customers are small shops. Recently Bloomberg pointed out that Square has run into issues in marketing its payment products to larger businesses globally.

Morgan Stanley is quoted in the article as saying that as Square enters the market for larger customers, competition on its pricing, hardware capabilities and breadth of offerings is heating up.

For example, Square recently lost Joe & the Juice, a privately held Danish company. Square had previously used this account as an example of how it is picking up larger customers. Joe & the Juice moved to Square’s competitor Ayden in order to unify with a single global processor across all its international markets.

Moreover, Square recently sold an online food ordering unit called Caviar which will hurt its growth rate in 2020 further. This was Square’s second largest subscription based business and so it will hurt Square’s recurring revenue growth rate.

Other large competitors like Shopify (NYSE:SHOP) and PayPal are getting into Square’s payments arena. CNBC recently reported that growing competition from these companies could pose a big threat to Square.

Meanwhile, Square is getting into Shopify’s micro-merchant tools arena with its recent $365 million Weebly acquisition. But Shopify bought Handshake — a former strategic partner of Square. So these companies are nipping at Square’s heels, effectively decelerating its sales growth rate.

What Investors Can Expect

Investors who pay 61x EBITDA cash flow don’t want to see decelerating growth and issues with client retention.

Expect SQ stock to basically grow into its valuation. That is to say, the shares will likely not outperform the S&P 500, as it has done so far this year, while the underlying fundamentals “catch up” to the high valuation.

The risk is that if the market takes a fall stocks like SQ stock will fall faster than the market. This would allow the market to reprice the valuation based on the company’s decelerating growth rates.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review here.

 


Article printed from InvestorPlace Media, https://investorplace.com/2019/09/square-stock-is-overvalued-for-a-growth-company-doing-less-growing/.

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