Shareholders are hoping Square (NYSE:SQ) stock delivers a better year in 2020. Square stock didn’t necessarily have an awful 2019; shares rose about 12%. But in context, that performance was rather disappointing.
First, most of the gains — and then some — came in the first month of 2019. Square stock still sits below where it closed January 2019, and currently 16% off a 52-week high reached at the beginning of August.
Meanwhile, the rest of the market soared last year, with the NASDAQ Composite rising 35%. Shopify (NYSE:SHOP), to which SQ stock is sometimes compared, nearly tripled.
Square stock has started 2020 off on a better foot, thanks in part to a nice gain on Tuesday. Shares were up over 4% midday after Bank of America (NYSE:BAC) upgraded SQ in a morning note. BofA’s upgrade makes some sense on its face. But it also highlights the questions that will dog Square stock in 2020, and perhaps beyond.
Square Stock Gets an Upgrade
Bank of America’s upgrade, at least based on media reports, makes some sense. Analyst Jason Kupferberg wrote that Square has a “favorable setup” in 2020. Sentiment toward SQ is mixed after the sideways trading that dominated most of 2019, including a late-year fade. Kupferberg wrote that the company’s initial outlook for 2020 revenue growth, given on the third quarter conference call, looks conservative.
The broad strokes here echo the case I made for SQ stock, if less forcefully, last year. The selloff after last year’s second quarter earnings report looked too severe. The sideways trading seemed to set up a base for a rally, in which SQ would join other soaring growth stocks like SHOP stock and Paycom Software (NYSE:PAYC).
In other words, Square had a pretty solid 2019 from an operational standpoint. Square stock did selloff after earnings reports on multiple occasions, despite beating estimates in all four releases. The weakness generally was driven by disappointing outlooks for the following quarter.
But, as Kupferberg points out, the company clearly has a pattern of guiding conservatively. It’s still a bit unclear why the market hasn’t incorporated that fact into its analysis of post-earnings reports. The gains after the third-quarter report — which featured a below-consensus outlook for the fourth quarter — suggest investors have adjusted. As was the case for most of last year, however, Square stock wound up giving those gains back.
The Risks to SQ Stock
I’m loath to criticize an analyst note based solely on thin media reports, but there’s a key issue with the thesis here. Again, Kupferberg isn’t alone in seeing value here, and I understand the case he’s making.
The one problem is that there’s nothing in that case not only priced into the market. We know Square guides conservatively: the company hasn’t missed estimates on either the top or bottom line going back to 2016. We know sentiment is mixed and that SQ stock struggled last year, particularly relative to other high-growth, high-multiple names. And, we know that Cash App is doing a nice job against PayPal Holdings’ (NASDAQ:PYPL) Venmo.
However, we also know that competition is intense, as InvestorPlace writer Thomas Niel detailed in November. Barron’s hit the same theme this month, noting new offerings from legacy payment giant First Data, now part of Fiserv Inc (NASDAQ:FISV), as well as private companies Verifone and Shopkeep.
Put another way, the bull thesis for SQ stock in 2020 also highlights the key question: what, exactly, will be different from 2019?
The 2020 Outlook for Square Stock
I’m personally skeptical at this point that enough will be different. I thought third-quarter earnings were somewhat disappointing looking closer. Guidance for 2020 does suggest strong top-line performance, with adjusted revenue growth in the “low 30s” excluding the sale of Caviar to DoorDash.
However, the margin benefits of exiting Caviar, which had struggled to compete against the likes of GrubHub (NYSE:GRUB) and Uber (NYSE:UBER), are being reinvested behind the payment business. That might be a way to drive revenue growth in 2021 and beyond. It might also be spending that is required to maintain share, as more rivals target Square’s market.
Even with relatively weak trading of late, Square stock is nowhere close to cheap. Shares are still valued at over 60x 2020 earnings per share estimates. Revenue growth is nice, but the company needs to drive better profit growth as well. That margin strength doesn’t appear to be coming in 2020.
And if it doesn’t, the rally in SQ stock probably doesn’t follow.
Beating and delivering conservative guidance wasn’t enough for Square stock in 2019. So, I’m skeptical it will be in 2020 either.
As of this writing, Vince Martin has no positions in any securities mentioned.
