A One Day Earnings Rally Might Be All Square Stock Will Get

The recent rally might be all there is for Square stock this year

Square (NYSE:SQ) had an intriguing bull case heading into its earnings release on Wednesday afternoon. Coming out of the Q3 report, Square stock admittedly still has that bull case.

A One Day Earnings Rally Might Be All Square Stock Will Get
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The problem, however, is that earnings don’t look quite strong enough to be the huge catalyst for which bulls were hoping.

So far, SQ stock has avoided the fate which befell it after the last three quarters. But an 8% rally seems to price in the news for the quarter — which means hoping for a rally back to 2018 highs of $100 might be too much to ask for.

SQ Stock Holds up After Earnings

From a headline perspective, earnings would seem bearish for SQ stock, at least if history is any guide. Both adjusted earnings per share (by 5 cents) and revenue (by a little over $5 million) came in ahead of analyst estimates. But guidance for the fourth quarter was below consensus on both lines.

That’s exactly how the last three quarters played out. And each time, Square stock plunged, falling 14% after the Q2 release, 8% after Q1, and 6% (over three sessions) following the Q4 report at the end of February.

This time, however, SQ stock actually gained 1.3% in after-hours trading. And the differing response does make some sense. For one, investors may finally have realized that Square guides conservatively. Second, the company’s sale of Caviar to DoorDash is having a larger effect on revenue than projected, which explains the soft top-line outlook for the fourth quarter.

This time around, the combination of an earnings beat and soft guidance has moved SQ stock up some 8%. That’s a nice gain in context: fellow growth name Roku (NASDAQ:ROKU) had a seemingly spectacular quarter and saw its shares plunge in after-hours trading. At least in terms of the initial reaction, investors seem at least content with Square’s report.

The Details Look Mixed

It’s also possible that investors are looking beyond the headline numbers — and there were some interesting developments in the quarter.

On the positive side, Square gave yet more detail on its Cash App product. Cash App seems to be competing well against PayPal Holdings’ (NASDAQ:PYPL) Venmo, and apparently it still is.

According to figures from the Q3 shareholder letter, Cash App revenue excluding bitcoin in the quarter was $159 million. PayPal said after its Q3 that Venmo had reached an annual revenue run rate just shy of $400 million — or less than $100 million a quarter.

Cash App thus seems to be outperforming Venmo. Square is seeing profits on that revenue too, with gross margins near 80%. Meanwhile, Square is adding new functionality to the app including fractional stock ownership, allowing it to compete with well-known start-up Robinhood and traditional discount broker Charles Schwab (NYSE:SCHW), which itself is launching fractional ownership.

Cash App performance seems like good news. But initial preliminary guidance for 2020 might shake investor confidence. Square said its EBITDA margins for 2020 would be roughly flat to the ~18% it expects this year.

Combined with a guided revenue increase in the “low 30s” on a percentage basis, that suggests EPS growth next year likely below current Street estimates, which project a 41% increase.

That projected revenue growth is about in line with expectations (the consensus estimate is for 33% growth). But part of the pressure on SQ stock, which still is down 38% from 2018 highs, has come from increasing fears that competition is catching up.

Square management positioned the lower margins as due to sales and marketing spend needed to drive growth — an investment that will pay for itself in a matter of quarters.  But some investors may worry that the spend is what’s needed to differentiate the company in an increasingly crowded space.

The Bottom Line on Square Stock

Again, Square stock is cheaper, but one concern at the moment is that it isn’t necessarily cheap. The 2020 consensus EPS still suggests a 60x forward multiple, and next year’s estimates may come down after this quarter’s commentary.

Even backing out cash, price to 2020 revenue is over 4x on a GAAP basis, and around 8x using the company’s ‘adjusted’ figure which will be discontinued after Q3. Adjusted revenue excludes transaction costs and bitcoin revenue, both of which offer minimal gross profit. In fact, Square made just $2 million in gross profit on bitcoin sales in the quarter.

In the market of the last few years, those multiples don’t necessarily stand out. But clearly investors have had some worries about SQ’s valuation of late — and those worries have spread to other growth stocks. Shopify (NYSE:SHOP), to which SQ stock often is compared, trades 25% below late August highs. Formerly high-flying cloud names have pulled back as well.

For that reason, I argued ahead of earnings that the relatively flat trading in Square stock was bullish. It certainly seemed to give Square an opportunity to deliver an earnings release that could re-ignite optimism toward its stock. An 8% rally suggests that case did play out. The problem is that I’m skeptical there’s enough in Q3 to keep that rally going.

As of this writing, Vince Martin has no positions in any securities mentioned.

Article printed from InvestorPlace Media, https://investorplace.com/2019/11/one-day-earnings-square-stock/.

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