Please ensure Javascript is enabled for purposes of website accessibility

Square's Facing Its First Real Test as a Business

By Adam Levy - Mar 19, 2020 at 9:05AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Square's growth is largely tied to businesses overly affected by coronavirus.

Shares of Square (SQ -2.21%) plunged on Monday and have fallen steadily all week as social distancing practices and policies have put a damper on in-store shopping and dining out. Coronavirus could have an outsized effect on small businesses compared to larger national chains. That's bad news for Square, whose merchant base is heavily weighted toward small retailers and restaurants.

Square was founded in early 2009, just as the United States was exiting its last recession. The last 11 years have been great for small businesses in the country. And as a result, things have been great for Square. But the spread of coronavirus -- and the policies enacted to slow the spread -- will put a real damper on the growth of small businesses and Square's core operations.

A person holding a smartphone making a payment at a Square Register in a restaurant.

Contactless payments at a Square Register. Image source: Square.

Square's competitive advantage

Square has exhibited exceptional growth over the last few years because of a couple of key competitive advantages. 

First, its ability to onboard new merchants inexpensively makes it an easy choice for small business owners. New Square merchants can simply navigate to Square's website, sign up, and purchase relatively inexpensive and easy-to-install hardware to set up a point-of-sale system. In fact, the vast majority of Square's merchants self-onboard.

Square's second competitive advantage is offering a suite of ancillary services like inventory management, business loans, payroll, and appointments that make managing a small business easier. Square's software is particularly tailored for small businesses. Competitors typically partner with other service providers to integrate similar offerings into their point-of-sale systems, but Square can offer a complete suite directly to its merchants. That suite of services actually enables Square to offer more competitive pricing in some instances.

But Square's competitive advantages don't extend well beyond small businesses. Larger businesses have more complex needs that Square isn't able to solve. And with its standard payment processing fees higher than competitors like Global Payments or First Data, larger businesses can typically save money by putting together their own solutions, even if it costs more upfront.

As a result, Square is largely reliant on the growth of small businesses. Even as the percentage of its total payments volume shifts to businesses with more than $125,000 in annual TPV, a lot of that comes from merchants that have grown after starting with Square as a micro-merchant. The percentage of payment volume coming from businesses processing more than $125,000 per year increased eight points over the past two years to 55% in the fourth quarter.

Is the risk priced into the stock?

After market concerns around Square's business wiped out nearly half its value, some investors think the risk is priced in. "We believe downside is limited at the current price," Cowen analyst George Mihalos wrote in a note to shareholders after Monday's price drop.

Mihalos believes the spread of COVID-19 will have a negative effect on Square in the short term, but the long-term story remains intact. That is, Square will continue to attract new merchants and grow attach rates for profitable ancillary services after we can all get back to normal life.

But there's still a very real possibility that extended store closures won't just reduce payment volume at Square merchants, but cause them to close up shop entirely. A large number of small business bankruptcies would be a major setback for Square, and could take much longer for the company to recover from.

So, while Square's stock price currently looks attractive, it's still a risky investment, as are many growth stocks. Since it's practically impossible to tell what the long-term effects of coronavirus will be on Square, investors who are more risk-averse may be better off avoiding it. Management should provide an update at its investor day next week.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Block, Inc. Stock Quote
Block, Inc.
$69.43 (-2.21%) $-1.57

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 06/28/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.