Stock investing is like a puzzle — you have to get the pieces together and it takes time and patience. Missing one piece can be detrimental because the puzzle cannot be completed. When it comes to Square (NYSE:SQ), the situation is no different. Square stock is missing that one essential piece.
For growth stocks, investors often focus on the prospects. But they also frequently neglect that one important part: valuation. Square is a growth stock with plenty of things to like about it, but it’s unfortunately way too overvalued.
So, can this name really be a stock to buy now? Or does that valuation make it a no-go?
Square Stock: Growth, But Not at a Reasonable Price
Growth at a Reasonable Price (GARP) is an investment philosophy that combines two very interesting and desirable criteria: growth and value. Simply put, it means that investors should try to find companies that show consistent earnings growth yet do not sell at valuations that are too high.
So, where does Square stock stand when it comes to this strategy?
According to MorningStar, Square has a three-year annualized revenue growth of 40.25%. What’s more, Zacks estimates that the company will have an expected earnings-per-share growth of 32.99% for the next three to five years. Those impressive numbers definitely make SQ a growth stock.
But what about value investing? Here, SQ’s valuation suggests it’s way too rich.
The current S&P 500 price-earnings ratio is 39.74, according to Multpl.com as of this writing. SQ stock, however, has a price-earnings ratio of 358.78 for the past trailing 12-months. Compared to the general stock market, SQ has an unjustifiable premium. Its forward price-earnings is also 196.08 — better, but still too high.
Additionally, the stock’s PEG ratio — which essentially combines both value and growth — is 7.23 according to Zacks. A general rule for PEG ratios is that a value of less than 1.0 suggests the stock is undervalued. So, Square stock’s ratio is also way too high — overvalued given the expected growth.
Square Has an Attractive Business Model
Square is a company that offers business tools, providing digital payment and point-of-sale solutions in the United States and internationally. It also offers software products, business loans and more. One of the most important products that Square has, though, is Cash App — a way to “send, spend, save, and invest” from your mobile phone.
The company’s third-quarter 2020 earnings report was strong and showed growth for revenue, a minor increase in net income per share, a substantial increase in sales and marketing costs and finally a surge in Bitcoin (CCC:BTC-USD) revenue.
For the three months ended on Sept. 30, total net revenue came to $3.03 billion, an increase of about 140% compared to its net revenue of $1.27 billion in Q3 of 2019.
Importantly, Square has been able to make its money in a diversified way: a combination of subscription and services-based revenue, transaction-based revenue, hardware revenue and Bitcoin revenue. But the largest contribution of revenue for Q3 came from that last source: Bitcoin.
SQ’s Bitcoin revenue surged to $1.63 billion, or about 54% of the total net revenue for the quarter. For Q3 of 2019, Bitcoin revenue was just a little over $148 million.
Square believes a lot in Bitcoin, seeing it as the future of digital payments as well as an investment asset. But the company is going to face continued competition in digital payments from key players, too, including Paypal (NASDAQ:PYPL), Visa (NYSE:V) and Mastercard (NYSE:MA).
All said, though, Square seems to be optimistic about Bitcoin and the idea that it will keep adding incremental revenue to its business. In fact, the company invested in Bitcoin back in late 2020, as a financial asset on its balance sheet.
Is Bitcoin the Future of Digital Payments?
For Square, that substantial investment “underscores Square’s purpose of economic empowerment.”
In early October of last year, the company announced that it had “purchased approximately 4,709 bitcoins at an aggregate purchase price of $50 million.” The company elaborated:
“Square believes that cryptocurrency is an instrument of economic empowerment and provides a way for the world to participate in a global monetary system, which aligns with the company’s purpose.”
The average price paid per bitcoin then was about $10,700. So, that investment has performed very well so far, more than quadrupling now with Bitcoin’s price at about $45,000. Still, back then this investment was just a fraction of Square’s total assets.
If Bitcoin is to appreciate further in the future, though, Square stock could do well. But this is just the optimistic scenario. If Bitcoin demand stabilizes — or even falls — its price should fall and that source of revenue would decline in turn. So, I am not convinced that depending on this source of revenue is a good choice for the long-term.
Currently, this company has strong growth and a promising future, but its valuation makes Square stock far too expensive.
Instead of buying now, investors should wait for Square’s Q4 results in late February of this year. That will provide a clearer view of the company’s financial performance.
On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.