Shares of Square (SQ -2.00%) have dropped 28% from the beginning of August after the company reported lower payment volumes than originally projected, in addition to an adjustment in net profit per share. The recent sell-off was an overreaction on both counts and needs to be unpacked to see where investors may have thrown the baby out with the bathwater.
Eventbrite not so bright
Square's projection of lower than expected net income per share was due to an investment in Eventbrite (EB -0.71%). In 2017, Square invested $25 million in Eventbrite. After the company decided to go public, Square's investment doubled in value as the investment converted into common stock.
Recent changes to accounting rules set by the Financial Accounting Standards Board (FASB) state that companies with an equity investment in other businesses must revalue the equity under mark-to-market valuation. This simply states that at the close of a quarter, a company must value any owned equity in a company to the market value or fair value of that investment. This new rule will "produce some truly wild and capricious swings in our GAAP bottom line", as stated by Warren Buffett, the CEO of Berkshire Hathaway. Buffett recommends looking at operating earnings rather than the bottom line.
As Eventbrite's shares have dropped 36% from its IPO, Square takes a hit on net income per share. For every $3 Eventbrite loses in share value, Square loses $0.01 in net income per share. The updated net income per share forecast of a loss between $0.06 and $0.10 is based on an Eventbrite share price of $16 at the end of the next quarter. As you can see, the accounting adjustment will increase volatility when looking at the bottom line, which can swing up or down depending on the external investments a company has.
Going the long way
As long-term investors, we are required to look forward beyond the quarter-to-quarter data, seeing where a company will be in 20 years rather than one or two years.
Historical revenue and gross payment volume were higher year-over-year (YoY) than in 2018, in addition to a lower net income loss. After removing the Eventbrite writedown of $5 million, Square lost only $2 million in the second quarter of 2019, an improvement over the $6 million loss during the same quarter of 2018.
Square owns the Cash App, a growing peer-to-peer (P2P) payment service. Reporting revenue of $260 million in the recent quarter ($135 million excluding bitcoin transactions), the Cash App is starting to make an impact. This application was designed to compete with Apple's Apple Pay, Paypal's Venmo, and Google's Google Pay.
The Global Newswire reported that mobile banking is expected to grow 25.2% annually through 2026, with North America contributing the largest share at 33.6%. The Cash App is on track to generate Square $540 million in revenue for 2019, 12% of the expected $4.41 billion in total revenue for 2019.
Don't abandon ship
As payment volume is up 25% year over year, and revenue is up 44% year over year from the recent quarter, Square is still a growth company now trading at a decent price to sales ratio of 6.27 – beating Paypal's 7.63. The recent accounting changes and volatile adoption rates from consumers will be rocky and have a direct impact on the day-to-day stock swings -- which long-term investors shouldn't be worried about. Square is getting close to profitability while moving within a fast-growing sector. Patient investors that can handle heavily volatility will be rewarded assuming growth stays on target.