Square's Earnings: Disappointment or Buying Opportunity?

Since posting disappointing guidance and announcing an unexpected sale of its Caviar foodservice platform along with its second-quarter earnings results, Square (SQ -1.68%) has lost more than 20% of its value. In this Industry Focus: Financials clip, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss what long-term investors should pay attention to.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on Aug. 5, 2019.

Jason Moser: Speaking of the market penalizing performance here, let's jump into our first story of the week here with Square's earnings. Square earnings came out late last week. To say that the market has punished the stock, I think, is probably an understatement. It does seem like it wasn't very happy, perhaps more so with the guidance than anything else. What was your takeaway on the quarter? It seemed like it was a good quarter. What are your takeaways?

Matt Frankel: Yeah, 46%, year-over-year growth in adjusted revenue. Cash app really stood out as something that was impressive. They've taken the Cash app from $1 million in quarterly revenue to $135 in quarterly revenue excluding Bitcoin over just a three-year period. Even the most optimistic analysts were expecting about $100 million in revenue by 2020. Square's Cash app has destroyed expectations.

The big thing that I think is throwing a wrench in the market is the surprise that Square is getting rid of Caviar. Caviar is a successful foodservice platform. There's a good case to be made for and against why they might have done that. People who are critical of the deal say they're getting out of a rapidly growing market. They sold it for $410 million, which sounds impressive, given that they bought it for $90 million; but remember, they bought it for $90 million in stock, which at the current price is actually worth a lot more than $410 million. So, you could say that they're selling at a loss. You can make that case. But on the other hand, Square got into the foodservice business to get their payment processing platform in a whole new industry. And it was successful. About $1 out of every $4 that Square processes right now is foodservice, so it's been a success. But competition in this space is tremendous. You have DoorDash, Grubhub, and a few others. The deal partners them with DoorDash. They're integrated into DoorDash's platform. Square's thinking, "Why limit ourselves to our own platform when we can integrate our payment processing system into everybody's?" Square Caviar was kind of proof concept, is the way I'm looking at it. They could definitely get a wider reach by partnering with bigger players in the space.

So, I'm not too concerned about it. Generally, I think the quarter was exactly what I wanted to see. To be perfectly honest, the Caviar sale did take me by surprise. Not that I think it's necessarily a bad move or a good move, but it was surprising. It adds uncertainty and surprise, which the market doesn't like in general.

Moser: The Caviar deal, I was actually pretty happy to see that. To me, Caviar has always been the one part of the business that didn't quite fit in with the rest of it. They stated, it's the low-margin part of the business, anyway. It was the low-margin revenue driver for the company. I think it was something that was a bit outside of the things where they were really trying to focus. Selling this thing to DoorDash will allow them the opportunity to continue to participate in this space, but perhaps more from a support role as opposed to dealing with the logistics that come with food deliveries. I don't know, for me, I was very happy to see that. It seemed to me like, the one thing that stood out in the call, an analyst made the point that they beat on the high end of guidance for the quarter, and that was great. And typically, when they do that, then you see them guide up. And they didn't guide up this time. But now, the reason why they didn't guide up was because of this sale of Caviar. They will be reaffirming guidance here shortly, as soon as that transaction closes later on this year. You can expect an update to guidance here soon. Again, I don't buy or sell stock based on guidance anyway. I don't know, it seems to me to be a very short-term reaction to some noise from the market. And then you've got this, I guess there's a double downgrade today on the stock which is playing out to the tune of another 6% or 7%, it looks like.

Frankel: Yeah, and the fact that the overall stock market's down a bit in the past weeks. This earnings doesn't really help.

Moser: Point worth noting.

Frankel: This definitely narrows Square's focus. Like you said, Caviar was definitely not in their main wheelhouse. It served its purpose. Like I said, bringing more payment processing volume. But it's not something they need to focus considerable resources on going forward. You mentioned it was a lower-margin business. They're focused on their small business ecosystem and their individual ecosystem with the Cash app and all that. This allows them to focus on the two key areas of the business.

Moser: Before we move onto our next story, I'll close with one interesting factoid here for you, Matt. Last quarter, when Square was preparing to announce earnings, the night before, the shares closed at $73 and change. The day after they reported earnings, the stock closed at $67 and change. Over the subsequent days, we saw it hit $62 and change. All of this was based on the same idea in regard to guidance. My point ultimately is that we know this is a volatile stock. It is a business that's building its way toward meaningful profitability. But it's going to take some time. It is going to be more volatile than other names. But it is still a good business. We've seen this happen before. I don't know about you, I think you'd agree with me -- I didn't see any red flags in this quarter that made me think, "Uh-oh, I'm not sure if I should be owning this stock at this point."

Frankel: No. I don't own Square because I thought they were going to be the leaders food delivery. That could be the only potential red flag. But that's not why I own the stock. All things being equal, if a company lowers guidance and nothing changes in my long-term thesis, that's a buying opportunity in my mind.