In recent weeks, payments stocks have been selling off, Square (NYSE:SQ) included. Trading for just over $250 per share on Nov 1, SQ stock today trades for around $185 per share. It may be showing signs of bottoming out, bouncing back after hitting prices as low as $170 per share. But I wouldn’t say now’s the time to buy.
Why? Two reasons. First, while the market’s shrugging off fears related to Covid-19’s Omicron variant, there’s another issue that’s not going away. That would be likely changes to Federal Reserve policy. As the central bank inches closer to tackling inflation, interest rates will likely go up. This will put pressure on growth stocks. In particular, growth stocks like this one, which trade for unsustainably high forward multiples (more below).
Second, rising rates isn’t the only thing that could fuel a drop for SQ shares in the next year. With its rate of growth slowing down, it’s going to get harder to justify its substantial valuation premium to PayPal (NASDAQ:PYPL), its main rival.
Although there are some things that could wind up kicking growth back into high gear, you may want to hold off buying for now.
The Latest With SQ Stock
Market-wide pressures have been pushing Square shares lower. Yet you can argue that recent news with the company has been largely positive. For example, as my InvestorPlace colleague Brenden Rearick reported Nov 29, news of CEO Jack Dorsey stepping down from his second job as CEO of Twitter (NYSE:TWTR), to focus all his energies on growing the global payments company.
Along with this, there’s the news of the company’s renaming of itself as Block. Much like how Facebook’s name change to Meta Platforms (NASDAQ:FB) signals to investors its big pivot toward the metaverse, this move signals Square’s pivot towards becoming a more blockchain/crypto-centric company.
Both developments are good news for the company’s long-term prospects. However, will they result in shares making a roaring return to $250, or perhaps it’s all-time high of $289.23 per share? I wouldn’t count on it. That is, assuming that hawkishness we’re seeing out of the Fed increases. The Omicron variant may end up being like the Delta variant. Bad news for public health, but not necessarily bad news for the economy/the market.
Fed policy changes, however, the situation’s different. With inflation no longer something it can call “transitory,” the changes it will have to implement to fight it could mean further declines ahead for this stock.
Square and Possible Multiple Compression
In my recent coverage of growth stocks, I’ve pointed a lot to rising inflation/interest rates, as something that could trip up high-fliers, as well as former high-fliers like SQ stock. I’ve even talked about it being a risk for SoFi Technologies (NASDAQ:SOFI), one of the company’s smaller rivals.
I may sound a bit like a broken record, talking about the impact of rising rates on growth stocks. Yet while, with the market’s pullback since Thanksgiving, you can argue that rising rates are priced in, that may be far from the case. Especially for stocks like Square. Even after falling more than 35% off its all-time high, it still trades at a super high price-to-earnings (P/E) ratio of 105.9x.
Even if conditions hold, and the Fed’s moves to fight rising prices are mild? Its high forward P/E ratio may not be sustainable. Why is that the case? Growth is slowing down. That’s clear from looking at its most recent earnings report. Looking into 2022, analyst consensus calls for the company’s top line to rise just 7.8%, versus revenue growth of 85.7% in 2021. Estimates also calls for earnings growth to slow down as well.
As its rate of growth moves closer to that of its rival PayPal, it’s going to be difficult for it to sustain its current valuation. For reference, PayPal today trades for around 44.5x earnings.
Bottom Line on This Former Fintech Favorite
I’ll admit that, just because growth may take a breather next year, that doesn’t mean Square necessarily deserves a much lower valuation. But keep in mind that compression due to slowing growth is atop compression due to interest rate changes. With two ways shares could get knocked down lower, it seems chancy to buy in at today’s valuation.
Things could still work in its favor. Interest rates may stay at historically low levels. The company’s moves into crypto could reaccelerate growth. So too, could the Afterpay deal, which after the deal close will make the company a major name in the “buy now, pay later” (BYPL) space.
Strong long-term prospects notwithstanding, SQ stock has more room to drop in the near-term. Even if you believe recent concerns are overblown, waiting for more weakness may be the best move.
On the date of publication, Thomas Niel did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Thomas Niel, a contributor for InvestorPlace.com, has been writing single-stock analysis for web-based publications since 2016.
