Guggenheim analyst Jeff Cantwell downgraded Square (NYSE:SQ) on May 8, suggesting that small- and medium-sized businesses are going to continue to suffer for the rest of 2020 and into 2021. Not only are Square’s gross payment volumes going to be hit, so too could SQ stock.
If you bought Square in mid-March, while I’m bullish on its future, I think it might be a good time to take some profits and move to the sidelines at least until the effects of the novel coronavirus on the economy are entirely understood.
The Sobering Reality
In 20 days in March, Square’s stock fell from $83 to as low as $32.33, by March 20. In the seven weeks since it’s managed to claw its way back to nearly $75. Those lucky enough to buy in the low $30s have more than doubled your money. On an annualized basis, you’re looking at a 900% return.
You’d be crazy not to book those profits to fight another day.
However, for those in this for the long haul, I’d get some dry powder ready, I think you’ll get an opportunity real soon to buy some more SQ stock at or near late-March prices. And, as I said, I’m bullish about this particular fintech.
In my last article about Square, I highlighted some of the reasons Macquarie analyst Dan Dolev thought its 63% sell-off in March was overdone. While he did believe that Square would suffer from the economic downturn of Covid-19, he argued its discounted cash flow per share was between $55 and $60.
That note was March 23, just a few days after it hit its 52-week low.
As a result, I concluded that Square’s Cash App would do enough for the company and its stock, that a buy in the $50s would work out just fine for long-term investors. While Square’s nowhere near the $50s at the moment, two things make me believe it could be there sometime soon.
The Economy Is a Mess
First, the April jobs report had 14.7% unemployment, the highest level since they began recording these numbers in 1948. In May, there’s expected to be more job losses, so even though reopening is happening in various states, the good times aren’t about to return anytime soon.
USA Today recently highlighted that banks are seeing spending move higher after a 30% drop at the beginning of the stay-at-home orders. Further, it points out that parts of Asia aren’t seeing a surge in new cases, which suggests once the U.S. gets through the next few weeks, things won’t be nearly as bad and we can go on spending.
I’ve been fortunate enough to be able to work throughout this ordeal. Despite this fact, I’m not nearly as confident about spending my paychecks without any consequences as I was six months or a year ago. Like large companies currently bolstering their balance sheets to withstand whatever impact the remainder of 2020 will have on their businesses, I’m trying to keep spending to a dull roar.
Now imagine all of the people who’ve lost their jobs. Do you think they’re going to flip a switch, go back to work, and blow the budget on a fancy new car or a bigger house? Heck, no.
Yes, sometime in 2021, people will come out of their hibernation state and start spending again. But like a sputtering car that has engine troubles, the economy’s not going to get better until what’s ailing it goes away. And that’s going to take a lot longer than a couple of months.
Secondly, analysts were expecting adjusted profits per share of 13 cents in the first quarter. Square delivered a 2-cent loss. I worry about Square’s transaction and loan losses.
In the first quarter, they were $108.9 million, 292% higher than a year earlier. More importantly, they accounted for 8% of its revenue in the quarter, up from 3% in 2019. Further, they accounted for 17% of the company’s operating expenses in the quarter, more than double a year earlier. Overall, these losses accounted for 39% of the increase in operating expenses during the quarter.
And they’re likely to get worse before they get better. The second quarter will likely result in even higher losses. Who knows about the third and fourth quarters, but Cash App is not going to be able to save the day entirely. At least not yet.
The Bottom Line on SQ Stock
In the first quarter, excluding bitcoin, Cash App revenue increased by 98% to $222 million or 22% of its net sales. Not only that, but its gross profit also grew 115% year-over-year to $176 million for a 79% gross margin.
In every respect, Cash App remains a big success. Ultimately, the value derived by Cash App to Square’s stock price is going to be significant.
For now, though, Square has to get through this rough patch. As a result, I think you can get a better entry point than $72.
Long term, it’s still a strong buy.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.