The financial technology industry is fast transforming the U.S. financial sector. Over the past few years, fintech stocks have exploded in terms of growth, with the evolution of digital payment-processing solutions. The COVID-19 pandemic further accelerated digitalization and has led to a spike in online transactions. As a result, payment and point-of-sale solutions leader, Square, Inc. (SQ) has been thriving since March last year.

SQ is the fastest growing fintech company in terms of digital wallet usage in the United States, and its popular Cash App has more than  30 million monthly transacting active customers. The company is arguably the best-known credit card acceptance solutions provider and it has benefited handsomely from the spike in e-commerce sales amid the pandemic and the shift to digital payments.

But, despite the favorable economic backdrop, shares of SQ have lost 11.95% over the past month.

Let’s take a closer look at the factors that are influencing SQ’s performance:

Baffling Acquisition

On March 4, SQ bought a majority stake in rapper Jay-Z’s Tidal music streaming service for a $297 million cash and stock deal. While investors are questioning the synergies between a music streaming company and a fintech major, SQ cited “financial freedom and economic empowerment to musicians” as a motive. The company plans  to improve artist connections through its Cash App and build a seller ecosystem dedicated to them. SQ also believes  the deal could popularize blockchain or other new approaches, such as non-fungible tokens (NFT), to store and establish digital media ownership.

Last year, Counterpoint Research claimed Tidal  accounted for only about 5% of the global streaming music market, placing  it far  behind leaders like Spotify Technology, Apple, Alphabet’s Google and Amazon. Moreover, Tidal is struggling to stay afloat and is currently generating losses. . Following the acquisition news, shares of SQ declined 6.7% to  $218.41.

Expected Slowdown in Growth Post Pandemic

Improving retail sales are hinting that e-commerce revenue growth would slow this year as stimulus checks and vaccine rollouts encourage people to return to stores and redirect  some of their  spending back to brick-and-mortar stores. While it’s too early to predict long-term trends for remote transactions, experts believe that digital payments have reached a tipping point and that online transactions will certainly take a major hit as the world returns  to the ‘old normal’ this year.

Recent Financial Results

In the fourth quarter (ended December 31, 2020), SQ’s revenue surged 141% year-over-year to $3.16 billion on the back of Bitcoin transactions over its Cash App ecosystem. SQ continued to focus on the impressive growth delivered by its Cash App ecosystem, which generated gross profits of $377 million, up 162% year-over-year. Its gross payment volume (GPV) rose 92% year-over-year to $32 million, with nearly 61% coming from larger sellers with volumes of at least $125,000 annually. However, its EPS came in at $0.59, declining 29% compared to the year-ago value of $0.83.

Stretched Valuations

In terms of forward p/e, SQ is currently trading at 182.65x, 629.8% higher than the industry average 25.03x. SQ is trading well above the industry average in terms of trailing-12-month’s p/s also (10.50x versus 4.22x).

In terms of forward price/cash flow, SNAP’s 124.81x is 490.4% higher than the industry average  21.14x.

POWR Ratings Indicate Bleak Prospects 

SQ has an overall rating of D, which translates to Sell in our POWR Ratings system. The POWR Ratings are calculated by considering 118 different factors with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight different categories. Among these categories, SQ has a Value Grade of D, consistent with its significantly higher-than-industry valuation.

SQ also has a D grade  for Stability, indicating that the stock is more volatile versus  its industry peers. Of 104-stocks in the D-rated Financial Services (Enterprise) industry, SQ is ranked #92.

Beyond what I stated above, we also have given SQ grades for Growth, Momentum, Sentiment and Quality. Get all the SQ ratings here.

Bottom Line

The pandemic has made a structural shift in consumer behavior as people have come to rely on online transactions for e-commerce, payment networks, online lending, money transfers, business-to-business payments, personal finance and banking. However, some trends will eventually slowdown as the pandemic abates and digital transactions could  be one of them. SQ has been efficiently leveraging  innovation, allowing small companies to accelerate growth even amid a challenging economic backdrop. However, investors must acknowledge that the stock had an incredible run over the past year to become largely overvalued. Hence, we believe, it’s better to avoid betting on it now.

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SQ shares were trading at $238.26 per share on Thursday afternoon, up $11.53 (+5.09%). Year-to-date, SQ has gained 9.47%, versus a 5.65% rise in the benchmark S&P 500 index during the same period.

About the Author: Sidharath Gupta

Sidharath’s passion for the markets and his love of words guided him to becoming a financial journalist. He began his career as an Equity Analyst, researching stocks and preparing in-depth research reports. Sidharath is currently pursuing the CFA program to deepen his knowledge of financial anlaysis and investment strategies. More...

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