Should Square Stop Sandbagging Its Guidance?

Square's stock (SQ +3.28%) recently dipped after the online payments provider posted its second-quarter earnings. At first glance, Square's headline numbers looked solid: Its adjusted revenue rose 46% annually to $563 million, beating estimates by about $5 million. Its adjusted EBITDA grew 54% to $105 million, and its adjusted EPS climbed 62% to $0.21 and cleared expectations by a nickel.

However, Square's gross payment volume (GPV), which grew 25% annually to $26.8 billion, slightly missed the consensus forecast of $27 billion. Square's guidance for the third quarter was also mixed.

It expects its adjusted revenue to rise 37%-39% annually, which matches analysts' expectations. But on the bottom line, it expects an adjusted EPS of $0.18-$0.20, which marks 38%-54% growth but misses expectations of $0.22 per share.

That guidance "miss" sparked a post-earnings sell-off, but investors should be accustomed to Square's sandbagged guidance by now. Let's discuss why Square sandbags its guidance, and whether it should stop playing this smoke-and-mirrors game with Wall Street.

Image source: Getty Images.

Why does Square sandbag its guidance?

When a company sandbags its guidance, it offers lower-than-expected numbers to temper analyst expectations. This lowers the bar for an earnings beat next quarter and prevents analysts from raising the bar too high with overly bullish forecasts.

When applied conservatively, the strategy can prevent a company's stock and valuations from rushing too far ahead of its business. Square's stock isn't cheap at about 100 times this year's adjusted EPS forecast, and it probably doesn't want that valuation to be inflated into an unsustainable bubble.

But when a company repeatedly sandbags its guidance it becomes predictable and obfuscates its true growth potential. Simply take a look at the gap between Square's guidance (which usually "misses" expectations) and its actual earnings over the past year.

Source: Square quarterly reports.

Based on that track record, we can safely assume that Square's third-quarter earnings will meet or beat Wall Street's expectations of $0.22 per share.

Should Square offer clearer guidance?

Square isn't the only company that plays the sandbagging game. Its rival PayPal (PYPL +1.90%), for example, previously estimated that its second-quarter adjusted EPS would come in between $0.68-$0.70, yet it posted earnings of $0.86 per share.

However, constantly "missing" guidance forecasts steals the thunder from Square's more important growth metrics. As of this writing, many media outlets are bemoaning Square's "downside" guidance instead of highlighting its 87% annual growth in subscription and services revenue, which was supported by the growth of its Cash App, Square Capital, and Instant Deposit services.

Square's Cash App nearly doubled its bitcoin revenue sequentially, indicating that it's becoming a popular platform for bitcoin trades, and the app remains a formidable rival to PayPal's Venmo in the peer-to-peer payments market.

Image source: Square.

Square's total hardware revenue also grew 21% as the company disrupts the POS market with its Terminal, Register, and Reader devices. Loans at Square Capital rose 36% annually and tethered more businesses to the company's expanding ecosystem of digital services.

Only a handful of outlets are discussing Square's sale of its food delivery platform Caviar to DoorDash for $410 million, a nice profit from its purchase price of $44.3 million five years ago. That retreat also indicates that it isn't interested in competing in the crowded, margin-crushing food delivery market.

The bottom line

I doubt Square will stop sandbagging its guidance anytime soon. But it should consider changing its ways, since clearer guidance could reduce the stock's near-term volatility, allow investors to focus more on its core growth engines, and paint a clearer picture of its long-term growth.