Square (NYSE:SQ) has recently given back a lot of its gains from last year. After briefly topping $100 per square, Square, Inc. Class A (SQ - Get Rating) stock has sharply reversed. Square, Inc. Class A (SQ - Get Rating) stock now trades for just $65, and has failed to recover, even as the stock market has roared back from its December lows.
It’s not hard to see why Square, Inc. Class A (SQ - Get Rating) stock has underwhelmed so far in 2019. The valuation of Square stock reached outrageous levels when the shares hit $100. At that point, the market was pricing in both huge growth by Square, Inc. Class A (SQ - Get Rating) and a sharp upturn in its profitability. Unfortunately, Square’s first-quarter results, unveiled on May 1, did little to support either tenet of the bulls’ thesis.
Earnings Were Fine But Not Enough
Square’s Q1 results were a mixed bag. If expectations for the company had been lower, investors probably would have been fine with the results. But given the high price of Square, Inc. Class A (SQ - Get Rating) stock, blowout results were needed to sustain its upward trend.
Square, Inc. Class A (SQ - Get Rating) reported non-GAAP earnings per share of 11 cents, which topped analysts’ consensus outlook of 8 cents. On a GAAP basis, the company continues to lose money. On the revenue side, it topped consensus expectations, but not by much. Its $489 million top line only modestly exceeded analysts’ consensus outlook of $480 million.
Some bulls pointed to the company’s escalating year=over-year revenue growth rate as a positive point. But, excluding the impact of Square’s recent acquisitions, its growth rate has been declining in recent quarters. Furthermore, analysts expect SQ’s growth to fall off sharply, from something in the high fifties now to closer to 40% next year. Obviously, 40% annual revenue growth is still great, but when the company is still only, at most, marginally profitable, the owners of Square stock will want its CEO, Jack Dorsey, to produce better results.
Square, Inc. Class A (SQ - Get Rating) Stock Still Has a High Valuation
Even after dropping 35% from its high of last year, Square, Inc. Class A (SQ - Get Rating) stock is really expensive compared with its peers. Square stock is trading around 7.5 times its 2018 sales and nearly 60 times analysts’ average 2019 earnings estimate.
Those numbers are much higher than the valuations of other payment tech companies. Maybe the current valuation of Square stock would make sense if Square, Inc. Class A (SQ - Get Rating) had recently carried out its IPO and was still early in its maturation process. But Square has been around long enough to start backing up its valuation. PayPal (NASDAQ:PYPL) stock is trading closer to six times its sales and 30 times its earnings.
Both WorldPay (NYSE:WP) and Global Payments (NYSE:GPN) look even cheaper than PayPal on the basis of these metrics, to say nothing of Square. The owners of Square stock have to ask themselves what makes Square, Inc. Class A (SQ - Get Rating) stand out from its competitors. Square dominates its niche of the smallest of businesses, but has struggled to gain traction with larger companies. As businesses’ volumes rise, Square’s fees tend to become less competitive. Jack Dorsey has to find a way to change that situation.
But Square, Inc. Class A (SQ - Get Rating) has some other irons in the fire. Its Cash App, for example, has had a strong run, though it appears that PayPal’s Venmo is catching up. Some of Cash App’s features, such as Bitcoin trading, could cause some users’ interest in Square, Inc. Class A (SQ - Get Rating) to rise, but that probably won’t be enough to drive Square, Inc. Class A (SQ - Get Rating) stock back to its old highs. Jack Dorsey needs something bigger, which brings us to…
Square’s Quest for a Banking License
The one thing that could really turn things around for Square, Inc. Class A (SQ - Get Rating) stock in a hurry would be a banking license. Square originally filed paperwork for a license in September 2017. It intended to become a Utah-based bank that would focus on small business.
However, after regulators expressed concerns about its application, Square, Inc. Class A (SQ - Get Rating) withdrew it. However, Square, Inc. Class A (SQ - Get Rating) refiled its application late last year. Why is Square so intent on obtaining a banking license? In theory, an FDIC-insured Square Bank would give Square, Inc. Class A (SQ - Get Rating) a large amount of disruptive power. Right now, Square, Inc. Class A (SQ - Get Rating) has to operate using its customers’ banks, which adds fees and friction. Square Bank would allow its small business customers to open their own accounts directly with Square, cutting out the middleman.
In theory, Square, Inc. Class A (SQ - Get Rating) stock should surge after it receives a banking license. But the license may never be granted. For one, the FDIC tends to be fairly cautious about granting banking licenses to more aggressive firms. I’ve been skeptical about whether Square’s small-business lending will earn high enough returns to offset the large credit risk of lending to tiny businesses. Its business model looks good during boom economic times but what happens during a recession? Perhaps regulators are wondering the same thing. Jack Dorsey will have to convince regulators that SQ’s business model will remain sound during economic downturns.
The Verdict on Square, Inc. Class A (SQ - Get Rating) Stock
Its last earnings report was underwhelming. With its valuation still far above that of industry rivals, Jack Dorsey needs to put up dazzling results to get its stock price moving again. Another earnings report that just barely tops expectations, let alone a miss, could send Square, Inc. Class A (SQ - Get Rating) stock lower in a hurry.
Square Inc. shares fell $0.13 (-0.20%) in after-hours trading Friday. Year-to-date, Square, Inc. Class A (SQ - Get Rating) has gained 15.28%, versus a 13.65% rise in the benchmark S&P 500 index during the same period.
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