Square (SQ - Get Rating) is a financial technology company with two units – a payment processing arm and a consumer-facing app. One unit helps small businesses accept card payments, provides reporting and analytics, and offers financing services. The company also has a consumer app for digital payments, wallets, crypto, and wealth management that has 36 million active users.

SQ’s stock price has been essentially flat since mid-January. However, during that time period, its POWR Ratings have endured a modest decline. This has come as SQ has underperformed the S&P 500 which was up 11% over this period.

Some of the reasons for its underperformance and decline in the POWR Ratings are a drop in its Momentum and Quality scores and a rough market climate for high-multiple, tech stocks.

The POWR Ratings is calculated by analyzing 118 different factors – each with its own unique weight. A and B-rated stocks have annual average performance of 30.7% and 19.3%, respectively.

While SQ has a lot of opportunity to grow in the long-term, its below-average POWR Ratings imply that at it’s current price the stock is overvalued.. 

Earnings Preview

In Q1, analysts are expecting $0.15 per share in EPS. This would be an improvement from -$0.02 per share in Q1 2020. Revenue is expected to be $3.4 billion, a 142% improvement from a year ago.

Another important metric is Gross Payment Volume (GPV) which tracks the total dollar amount of card payments processed by businesses using SQ’s payment system. SQ was negatively affected by the pandemic but has been able to offset this with growth in online sales and the Cash App. So, the company could benefit from the gradual reopening over the past couple of months.

Momentum and Quality Score Decline

The POWR Ratings also evaluates stocks by different categories to give more insight to investors. Notably, since SQ’s Q4 earnings, the company’s momentum and quality scores have softened.

In terms of momentum, SQ has gone from a leading stock to an underperformer. In fact, SQ’s stock price is basically flat over the past 6 months, while the S&P 500 is up 25% over that time period. Stocks with strong momentum stocks tend to outperform on multiple timeframes.

In terms of Quality, there are a couple of factors. Analysts have gently pulled back on SQ’s earnings estimate over the last couple of months for this quarter. Recent revenue growth has come from cryptocurrency trading which comes with minimal margins. This has resulted in profit margins collapsing from 8% to 2.2% over the last six quarters.

Tech Turbulence

SQ is a leading fintech stock. And, fintech is one of the most exciting growth categories in the market. In many Asian and South American countries, younger people are handling all their financial activities through apps similar to Square’s Cash app.

It’s quite likely that young people who are currently using the app for payments and crypto-trading will eventually use it for banking, investment, wealth management, credit, and to buy financial products. This means that Square’s total addressable market (TAM) is massive, and investors are understandably enthused about SQ’s potential.

However, some portion of this is certainly reflected in SQ’s stock current price based on its high multiples. Currently, it has a price to earnings ratio of 805 and a price to sales ratio of 11.2. While high-multiple stocks can continue moving higher in many cases, they face a potent headwind in high-growth environments with rising, long-term rates which describes today’s environment.

This naturally leads to multiple contractions as strong economic growth likely means that the best revenue and earnings growth opportunities may be found in cyclical stocks.

Conclusion

SQ is reporting earnings later today. The company has topped earnings estimates for 4 straight quarters. Earnings estimates have trended higher since its Q4 report but slightly been tapered over the past month.

Investors should pay attention to the results to get a sense of whether growth is slipping. Additionally, the company will face elevated comps in upcoming quarters as the pandemic led to a surge in user growth.

SQ shares were trading at $219.03 per share on Thursday afternoon, down $12.84 (-5.54%). Year-to-date, SQ has gained 0.64%, versus a 11.74% rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...

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