Please ensure Javascript is enabled for purposes of website accessibility

Should You Buy Square Stock at Its All-Time High?

By Leo Sun – Jun 29, 2020 at 10:46AM

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

Investors seem to be pricing in the end of COVID-19 headwinds and a full economic recovery.

Square's (SQ -5.37%) stock recently hit an all-time high as smaller businesses, which generated nearly half its transactions last quarter, gradually reopened amid slowing COVID-19 infection rates and some relaxation of stay-at-home measures in the U.S.

But is that enthusiasm, which propelled Square's stock from the high $30s per share in late March to over $100 a share, justified or premature? Let's reevaluate the bear and bull cases for this technology and financial services company to find out.

Square Stand being used in a bicycle shop.

Image source: Square.

Is the COVID-19 crisis really over?

Square's revenue rose 44% year-over-year in the first quarter, which ended on March 31, but it didn't provide any guidance for the second quarter or the full year. However, its seller gross payment volume (GPV) fell 39% annually during April, with most of the decline occurring between the last week of March and the first half of April.

During the conference call on May 6, CFO Amrita Ahuja said the "trend line stabilized at these levels" and Square had seen "improving growth rates since mid-April." She noted it was "still early and we continue to see daily volatility, but we've been encouraged by these recent trends."

Those comments, along with the gradual reopening of businesses across the U.S., suggested the worst was over. However, a recent surge in fresh COVID-19 cases has sparked fears of a second wave of infections, and a growing number of states are shutting down again.

The pessimists vs. the optimists

Last quarter, Square attributed its stabilizing growth to new sellers pivoting to digital payments throughout the crisis, existing sellers using more omnichannel solutions, and seasonal boosts from Easter sales and stimulus checks.

Square for Retail being used at an apparel store.

Image source: Getty Images.

Forty-eight percent of Square's sellers generated less than $125,000 in annual GPV last quarter. These smaller merchants are highly vulnerable to the COVID-19 shutdowns, and Square has offered assistance by refunding its software fees in March and April, and providing more delivery, curbside pickup, and contactless transaction tools to help merchants stay open.

Square is willing to take near-term losses to support its smaller merchants, but it's unclear if these moves can consistently counter the broader macro headwinds -- including new COVID-19 infections and a U.S. unemployment rate that could hit 20% by the end of the year, according to a recent Refinitiv survey.

Square also remains consistently unprofitable on a GAAP basis, and the prolonged subsidization of its merchants could burn through a lot of cash, even after it recently raised cash with a $1 billion debt offering. Square's Cash App is still growing, and it remains ahead of PayPal's (PYPL -2.66%) Venmo, but Cash's growth isn't significant enough to offset the near-term slowdown in Square's payment processing and software fees.

Do Square's profits and valuations matter?

Analysts expect Square's revenue to rise just 4% this year as it deals with the fallout of the COVID-19 crisis, but accelerate to 33% growth next year.

Its adjusted (non-GAAP) earnings, which exclude stock-based compensation and other variable expenses, are expected to plunge 68% this year but more than triple next year.

At $100 a share, Square trades at over 100 times next year's earnings. PayPal, which is firmly profitable but is growing at a slower rate, has a much lower forward P/E of about 50. Square commands that premium because the market is pricing in the end of the COVID-19 crisis and the broader recovery of small businesses -- neither of which is guaranteed at this point.

Waiting for a pullback is a better idea

I bought more shares of Square during the COVID-19 crash earlier this year since I'm still impressed by the long-term growth potential of its fintech ecosystem. However, I believe its stock is overheating again, and investors who accumulate too many shares up here could be burned by a second wave of COVID-19 infections and shutdowns.

Leo Sun owns shares of Square. The Motley Fool owns shares of and recommends PayPal Holdings and Square and recommends the following options: short September 2020 $70 puts on Square and long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

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.
SQ
$55.90 (-5.37%) $-3.17
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
PYPL
$88.70 (-2.66%) $-2.42

*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
342%
 
S&P 500 Returns
107%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/29/2022.

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.