When Square (NYSE:SQ) reported its earnings earlier this month, Square stock tried to break out over the $66 mark. However, SQ stock fell short, retreating from $66 and pulling back into the low-$60s. After moving sideways for about a week, Square stock is starting to look worth buying.
Square stock has not been profitable for its owners lately, as it’s still down more than 35% since peaking at $101.15 in October 2018.
Bulls want to know if sentiment towards SQ is starting to improve, potentially lifting SQ stock. One major gripe with Square has been (and to a large extent, still is) its valuation.
After the company’s strong growth over the past 12 months, a 30%-plus drop by Square stock, and forecasts of further growth, SQ looks much more attractive than it did a year. Even those who are bearish on Square stock should be able to agree on that. But that doesn’t necessarily make the shares cheap. Let’s look at SQ a bit more closely.
Valuing Square Stock
SQ stock still trades at roughly 83 times analysts’ average earnings expectations. While the average earnings per share estimate of 78 cents per share is way above the company’s 2018 EPS of 47 cents, SQ is still trading at a premium.
Analysts believe the company’s earnings will rise 66% this year, but they expect its growth to taper off to “just” 24.5% in 2020. The story is similar on the revenue side. Average estimates call for roughly 42% sales growth this year, followed by 28.5% growth in 2020.
Even though the company’s 2020 outlook is impressive, investors are still paying a premium for that positive outlook.
Trading at 12.5 times its revenue, SQ is expensive compared to a company like PayPal (NASDAQ:PYPL), which trade at about 6.9 times its revenue. And while some may say that Visa (NYSE:V) and Mastercard (NYSE:MA) are just as expensive, if not more so (they trade at 15.7 and 16.7 times their revenue, respectively), profitability does matter.
For instance, Visa has gross margins of more than 81%, double the 40.2% gross margins of Square. PYP, with 44.7% gross margins, is closer to Square, but there’s a bigger difference when it comes to operating margins. Visa boasts trailing operating margins of 52.5%, while Mastercard’s stands at 42.5%. PayPal’s operating margin is 14.9%, while Square’s is closer to break-even.
That said, Square has a great business and while its valuation is high, that’s one of the few problems of Square stock. Increasing competition is another concern, as is the economy. If the economy shrinks, almost all businesses will be hit, but Square will take a bigger blow than most companies.
In short, Square’s valuation has improved tremendously from a year ago, but it’s not exactly a tailwind going forward. Square’s impressive growth will have to continue to support the current valuation of Square stock. Let’s look at the charts.
Trading SQ Stock
Click to Enlarge
As you can see on the chart above, SQ stock initially charged toward the $66 level after reporting its earnings. However, after reaching that level, the shares quickly retreated.
Luckily for bulls, the $61 to $62 area acted as support for SQ stock. That is also where the 78.6% retracement and uptrend support (depicted by the blue line) came into play. The 50-day moving average is near that area as well.
So what now? The setup gives us several clues. We know where buyers continue to step in when SQ stock falls, making it the key point on the charts. For instance, if Square stock falls below $61, we would know to get out of the way, as its major support had been breached.
Pullbacks to the $61 area can be bought, but pay attention to the 50-day moving average and uptrend support. These levels are not static and will continue to fluctuate. Changes in the 50-day moving average and uptrend support could make the $61 to $62 area less attractive in the future.
Another level to watch is $66. A close above that mark would almost immediately put the 200-day moving average on the table. Near $71, Square stock can begin filling the massive post-earnings gap from August.
So is SQ stock worth buying now? I’d say it’s closer to a buy than a sell. That said, it’s not a screaming buy at this point. Let’s see if we get a pullback worth buying or a close over $66.
Bret Kenwell is the manager and author of Future Blue Chips and is on Twitter @BretKenwell. As of this writing, Bret Kenwell is long V.
