When will the weakness of Square (NYSE:SQ) stock end? Despite a pretty good year for tech stocks, SQ stock has struggled throughout 2019. And lately, things have been going from bad to worse, as Square stock fell below the $60 mark again recently before making a modest recovery.
Analysts have added to the general negativity towards Square stock. More analysts have “hold” or “neutral” ratings on SQ stock than “buy” or “outperform” ratings.
That’s quite rare, particularly for a promising growth company like SQ. However, analysts are frustrated by Square’s uneven profit margins and the lack of certainty regarding its income over the next year. That uncertainty is due to the company’s flood of investments in its non-core businesses. How should investors view the debate around SQ stock?
High-Growth Stocks Have Been Under Some Pressure
Aggressive, high-valuation growth stocks in general have not had a great autumn. The slump of multiple software-as-a-service (SaaS) and cloud stocks appears to be spreading. For the time being, the collapse of WeWork has caused investors to flee many speculative growth companies. That’s an understandable reaction. But some folks may be dumping good stocks along with the losers.
Many of the SaaS stocks dropped as much as 30% from peak to bottom before starting to recover last week. Even payment names like Visa (NYSE:V) and PayPal (NASDAQ:PYPL) were getting hit until PayPal came through with great earnings last Wednesday.
Now Square stock’s drop doesn’t look quite so bad. Still, the company has clearly underperformed both its payment peers and the tech sector.
The Valuation of SQ Stock Is Steep
The main issue that analysts dislike about SQ stock is that its revenue growth has fallen significantly. Yet the company still hasn’t become meaningfully profitable. The forward price-earnings ratio of SQ stock still comes in above 50, which is rather steep.
A huge valuation multiple would make sense if Square still had a clear path to growth. However, its revenues are decelerating, with its competition mounting. It’s far from certain how successful Square’s investments outside of its core payment business will be, either. More than 50 times forward earnings and nearly seven times sales is not exactly a cheap price for SQ stock given those facts.
Will Cash App Become a Big Success?
A big part of the reason for the conflicting narratives around SQ stock is what to make of Cash App. The bulls can certainly make a solid case for Cash App being a strong driver of SQ stock going forward.
The revenue of the Cash App ecosystem has reached a run rate of about $1 billion annually. Net revenues are less, of course, but they are still running well over $500 million annually at this point, making up a meaningful part of Square’s overall $4 billion in annual sales.
And you have to give credit to Square’s management team for being innovative. It made bitcoin trading a main feature of the Cash App well before other services got into that game. Similarly, Cash App recently launched an effort to offer free stock trading within the application.
Both of those specific efforts come with clear downsides, however. Bitcoin’s price has never come close to reclaiming the heights of late 2017, and after a rally earlier this year, crypto is skidding lower again.
Meanwhile, the effort to be the Robinhood of stock trading fell flat as Charles Schawb (NYSE:SCHW), TD Ameritrade (NASDAQ:AMTD) and a host of other brokerages just announced commission-free trading as well.
Consumer financial services is exceptionally competitive, and it’s not clear that Cash App has established much of a meaningful and durable competitive advantage. Its business has done well so far, and Square’s leadership deserves credit for that. But it’s hard to get a good sense of what Cash App will be worth to Square in five or ten years. There are simply too many unpredictable factors at this point.
The Verdict on SQ Stock
I’d love to get on the bandwagon of Square stock. There’s a lot to like about SQ, particularly if it can keep evolving Cash App so it stays on top of emerging consumer trends. SQ certainly has the potential to be a stock that, over the long-run, produces multiples of one’s original investment. And with the shares down 40% from their all-time highs, the entry point is certainly reasonable.
That said, there are still a few too many question marks on SQ stock for me to get completely on board. And the bull case seems a bit too easy. Payments is a difficult business; for every PayPal that succeeds, there are a bunch of also-rans that have fallen by the wayside.
Twitter (NYSE:TWTR) successfully turned things around, or at least was on the right path until recently. So folks believe that Jack Dorsey, the CEO of both companies, can potentially achieve similar success with Square. But the payments business is harder than advertising on social media.
SQ could certainly be successful. The selloff of tech stocks generally is overdone, and SQ stock will probably bounce going forward There is a lot left to prove in terms of the longer-term investment case, however.
At the time of this writing, Ian Bezek owned none of the aforementioned securities. You can reach him on Twitter at @irbezek.
