Despite a rocky beginning in 2016, Square, Inc. (SQ 0.13%) stock has recovered nicely in the last six months and now trades within shouting distance of its all-time high. The recovery was driven by improving financial results, helped by growing adoption of its products and an improving cost structure.
But Square is still a young company fighting an uphill battle in payment processing. And it's losing money. With that in mind, there are some things investors should keep in mind when looking into the stock.
Image source: Square.
Competition isn't giving up
Square is far from an industry leader in payment processing. And companies who have market share, primarily in mobile transactions or adjacent businesses, won't give up the market to Square easily. They also have much bigger territories to protect, which is a challenge for Square.
PayPal Holdings Inc (PYPL +1.25%) and Intuit Inc. (INTU +1.09%) are the two public companies to watch in Square's line of business. PayPal is particularly formidable because it's an established payment processor and did $87 billion in total payment volume in the third quarter alone, much more than the $13.2 billion in gross payment volume for Square in the quarter.
Intuit isn't the same powerhouse in mobile payment processing, but it's the standard in accounting and tax software for millions of people and businesses across the country. It has its own competing payment service called GoPayment. And with a seamless tie to QuickBooks, it's a big draw to consumers. With a little work, it could leverage that position to eat away at Square's core payments business.
Growth could slow
Competition taking market share leads into what will happen on the income statement if Square's business loses steam. What's worth watching here is whether or not competitors like PayPal and Intuit are able to take Square's potential growth or even existing customers with their products. If they can, revenue growth that's surged in the last year would slow and the $236 million in losses reported over the past year would make the stock look extremely expensive.
Slower growth doesn't have to come from competitors, either. A slower economy or fewer small businesses looking to use mobile payments could also hurt Square's stock in 2017. To put expectations into perspective, analysts are expecting revenue to grow 24% in 2017 to $2.11 billion. If growth falls short of that bar, the stock will almost surely fall.
Profitability never emerges
The hope for Square's investors is that the company can grow payment volume, and therefore revenue, without operating costs increasing too much. If that happens, losses will subside, revealing a profitable business and the stock could rise.
But projections about Square's future profits are just that: projections. And if Square's revenue growth doesn't live up to expectations, or operating costs increase more quickly than revenue, investors would be disappointed.
What's interesting to note here is that analysts are currently putting much more emphasis on growth than on bottom-line profits. They're still expecting Square to lose $0.30 per share next year, only slightly less than the pace of losing $0.34 per share in the last two quarters. Investors will want to see a move toward profitability over the next year, but losing money and growing more quickly may be a good trade-off for lower profits if investors are given the choice.
