Should You Buy SQ Stock Ahead of Earnings?

In the short-run, SQ stock is likely to be volatile with a downward bias

During the last decade, fintech has been experiencing rapid global growth, and Square (NYSE:SQ) has been at the forefront of the revolution. To the delight of early investors, SQ stock has shown phenomenal growth. Its share price has skyrocketed over 1,000% since its IPO in November 2015.

Square, Inc. logo seen displayed on smart phone. Square, Inc. is a financial services, merchant services aggregator, and mobile payment company
Source: IgorGolovniov / Shutterstock.com

Yet, that metric only tells half the story. On March 18, SQ stock saw a 52-week low of $32.33. Then in early July, it hit a 52-week high of $133.81. Square is currently flirting with $130. Put another way, $1,000 invested in Square shares in early spring would be worth around $4,000.

As the earnings season approaches, shareholders are wondering whether Square will be able to make another significant leg up any time soon. I’d urge investors to exercise caution at current levels and consider taking some paper profits in the shares.

If you do not currently hold shares in the company, you may regard any upcoming dip as an opportunity to go long the shares. Here’s why.

What to Expect from Q2 Earnings

Square offers a wide range of services that enable transactions between merchants and their consumers. Its range of offerings include financial and merchant services, a mobile payments platform, as well as hardware such as point of sale (PoS) equipment. Through Square Capital, the business has also moved into small business lending.

When Square reported Q1 results in early May, revenue came at $1.38 billion, marking a 44% increase YoY. Its gross profit was $539 million, a 36% increase YoY. However, Square’s adjusted quarterly loss was 2 cents per share. This loss compared to an earnings of 11 cents per share a year ago.

The company reported revenue in four main segments:

  • Transaction-based revenue (about 55% revenue);
  • Subscription and services-based revenue (about 21/5% contribution);
  • Hardware revenue (about 1.5% contribution);
  • Bitcoin revenue (about 22% contribution).

Transaction revenue consists of fees that sellers pays to Square to process their payment transactions, net of refunds.

Square’s subscription and services-based revenue is increasingly becoming a key catalyst for the company. Cash App, Square Capital, and Instant Deposit are the contributors to revenue.

Analysts also pay attention to Square’s quarterly gross payment volume (GPV), or the total amount spent through the company’s payment processing platform. In Q1, it was $25.7 billion, meaning a 14% increase YoY.

Q1 earnings showed that Square’s popular peer-to-peer Cash App ecosystem experienced high volumes. Yet the Seller ecosystem, which provides financial services to merchants, had a significant decline in the last two weeks of the quarter due to the pandemic. Finally, management gave lower-than-expected guidance for the second quarter.

When Square reports Q2 earnings soon, investors are likely to pay attention to growth rates. They would like to see whether transactions may be falling due to the coronavirus. It is also important to remember SQ stock becomes rather choppy around its earnings release date. Therefore, investors should be ready to price swings in the coming days.

What Could Derail SQ Stock Soon

With a market cap of almost $57 billion, the payment company, headed by Twitter’s (NYSE:TWTR) CEO Jack Dorsey, is large and well-financed. The global payments industry is a $100 trillion-plus market, and developments in fintech are fast becoming the engine of change for so many businesses.

It would be fair to say that SQ is not yet finished growing and is likely to become a more dominant force in fintech in this new decade.

In the short-term, though, shareholders shouldn’t expect smooth sailing. SQ stock is about $100 higher since its 52-week lows in March. However, earnings estimates for Q2 and 2020 have fallen significantly. In other words, the recent rally in many tech stocks, including Square shares, are in part based on optimism regarding a V-shaped economic recovery.

Yet, the current fear of a second wave of the pandemic is making many market participants wonder whether share prices can increase any more in the rest of the year. Therefore, short-term profit-taking may be around the corner in Square stock.

Furthermore, given the recent increase in SQ stock, the shares have become rather overvalued. Let’s take a closer look at various metrics.

Square’s forward price-to-earnings ratio is over 243. Compare with PayPal (NASDAQ:PYPL), and Fiserv (NASDAQ:FISV), two competitors. Their respective forward P/E ratios stand at about 54 and 22.

Similarly, Square’s current price-sales ratio is over 12.1. Analysts prefer a low P/S multiple, ideally below 1x. However, a P/S number between 1x and 2x is more common. To put the metric into perspective, the S&P 500’s average price-sales ratio is 2.2x.

Comparing various metrics indeed makes Square stock look rather expensive. Furthermore, such high valuation levels allow for a low margin of error when it comes to quarterly earnings.

The Bottom Line on SQ Stock

In this new decade, a truly digital-first era will be part of our lives. Thus, Square’s long-term growth potential will likely drive the share price a lot higher. Yet I believe SQ stock will be volatile in the coming weeks as the company releases quarterly earnings. Like many momentum plays, Square stock will soon probably be a battleground between two camps: investors and traders.

Unless management beats expectations and raises guidance in several days, the current bullish momentum in SQ stock may not be able to last. If you are an investor who also pays attention to technical charts, short-term price action urges caution. Recent investors who rode the leg up since March may decide to take some money off the table. Therefore for now, the stock is likely to trade in a range, between $110 and $125.

If you are not yet a shareholder in the company, you may want to wait several weeks before committing new capital into SQ stock.

But if you already own the shares, you may want to ride out any further choppiness. Alternatively, you could consider initiating a covered call position. For example, a Sept. 18 expiry ATM (or slightly ITM) covered call would give you some downside protection in the coming weeks. It’d also enable you to participate in a potential up move.

On the other hand, SQ stock have strong technical support in the $100-$110 region. Therefore, investors may regard any fall in the share price towards these levels as opportune times to add the company to a long-term portfolio.

Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, including a Ph.D. degree, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation. As of this writing, Tezcan did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2020/08/should-you-buy-sq-stock-ahead-of-earnings/.

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