Square Earnings: Why Is the Stock Under Pressure?

One of our favorite fintech companies, Square (SQ 5.84%), just reported third-quarter earnings that beat estimates, but the stock has been under pressure since the report. In this Industry Focus: Financials clip, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss Square's latest results, why the stock has fallen, and what could be next for the company.

A full transcript follows the video.

This video was recorded on Nov. 12, 2018.

Jason Moser: Well, Matt, I know that you and I were excited to kick off earnings coverage this week talking about one of our favorite businesses out there, Square. Square reported, to my eyes, a very good quarter. There were a lot of good things to take away. The stock certainly has been selling off since the release. The point I was making over the weekend was, No. 1, the Friday sell-off really took it back to where it started the week to begin with. Then, we've seen some selling in the market today. Of course, there's been some additional volatility with Square. It's never been a stock that looked cheap by any means, because really, they're still getting started. Valuation has always been a key risk here.

When you look at a quarter like this, you see a lot of good signs there. To me, the one that stands out with a company like Square, I always look to gross payments volume to get an idea as to how healthy the business is. How many people are using it? What is that volume looking like? For me, I'm really encouraged here. Gross payments volume was up 29% from a year ago to $22.5 billion. I like to put that into context with other players in the space. If you look at PayPal, for example, for the same quarter, their gross payment volume was $143 billion, and that was up 25%. Square looked like they picked up a little bit of share there, a little bit of a faster growth rate there for Square.

All in all, I was very encouraged by the quarter. What's your take?

Matt Frankel: You're right, gross payments volume is the still by far their No. 1 revenue stream. One of the big reasons it sold off is, growth slowed down a little bit, 29% as opposed to 30% year over year growth last quarter. A 1% dip, we're not that concerned about. I'm definitely not.

The thing that really stood out to me was their subscription services revenue. This is still a pretty small part of Square's business. It was about 19% of the revenue total. This includes things like their Caviar platform, Square Capital, the business lending service, the Cash card that's linked to people's Square Cash app. Subscription services revenue was up 155% year over year. That's an amazing growth rate, and it's still a pretty small portion of the total. If they can even maintain half of that growth rate for a few more years, this could become a serious force to be reckoned with.

Another one is, hardware revenue was up. To be clear, hardware is not a big part of Square's revenue. It's about 2% of their overall revenue. But when they're selling more hardware, that means more sellers are adopting their product, which is a very good sign. Especially their newer products that are geared toward larger sellers with higher payment volumes, like the Square register all-in-one payment terminal, as opposed to the little card readers that you see in a craft market. That's a very encouraging sign, as well. Remember, Square has yet to monetize their Cash app, which is, the most popular of all of their products and services, in terms of number of users.

Having said that, this quarter looked really, really good. Just, like I said, a 1% slowdown in growth. Their fourth quarter guidance was not quite what the analysts had been looking for. We really don't care that much about guidance if all the numbers look great from a long-term standpoint.

Moser: You mentioned the hardware side of the business. For lack of a better descriptor, it's kind of like the gateway drug. You give your merchant a taste of how easy that transaction process can be. But it's really about getting that hardware in their hands so that they can experience how convenient and helpful the software side of the business can be. I feel like that's where their secret really lies. That's why we hear them talk so much about all of this different software they're developing for different particular markets, whether it's retail-specific or restaurant-specific. They do not look at this as a one-size-fits-all. It's kind of a bespoke way of approaching things, but it seems to be working.

I know that one of the biggest questions in the near-term for this company is going to be finding a new CFO, of course. Sarah Friar is getting ready to step down. I believe this was her last conference call. She's obviously been a rock star for the company up to this point. Do you have any feelings there as to whether this should be an internal hire that comes up? Or do they need to look externally? Do they have a time limit here that you're looking at? Is this something you feel like needs to be taken care of ASAP? Or can we be patient?

Frankel: The sooner, the better, especially in terms of the stock price. The market hates uncertainty in any form. Having said that, I have full faith that Jack Dorsey and his team will find the right person for the job. You'll know if the market thinks they're the right person by the stock's reaction after the announcement. Whether it's an internal hire or not, I have full faith that they'll find the person that they need to. In the long-term scheme, the grand scheme of things, this is going to be a non-issue. In the intermediate term, Sarah Friar has been an absolute rock star CFO. It's going to be some big shoes to fill. But the growth potential of this company is bigger than any one person. As long as they get the right person in for the job, I think they'll do just fine long-term.

Moser: Yep. Sounds like Jack Dorsey is going to need the support of his team here. I'm sure he'll get it.