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Why Square Stock Just Dropped 6%

By Rich Smith – Aug 7, 2020 at 3:24PM

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It wasn't what an analyst said but how it was said.

What happened

Investment banker BMO Capital raised its price target on point-of-sale payments processor Square (SQ -4.18%) this morning, reports TheFly.com. Having previously valued the stock at $116 a share, BMO Capital now thinks Square is worth nearly every dollar of the $154 the stock's share price closed at last night. (BMO's new target price: $153).

And yet, Square stock plummeted on the news, falling 6% in afternoon trading today. Why is that?

A red stock arrow breaking up and showering down in pieces over a city below

Image source: Getty Images.

So what

The problem, it seems, wasn't so much what BMO said about Square this morning -- it was the way BMO said it.

According to the analyst, Square's Q2 performance, reported earlier this week, was plenty strong, with sales soaring 64% and beating analyst predictions soundly. Square is employing its Seller and Cash App ecosystems to build the foundations for long-term earnings growth, says BMO. And with business booming, the analyst thinks the stock is worth more now than it was worth before earnings -- and that Square might well earn twice as much this year ($0.54 per share) as BMO had previously predicted ($0.23 per share).

So far, so good, right? But here's the thing: After delivering all these compliments to Square's business, BMO then proceeded to point out that Square's stock, which has more than doubled in price over the past year, is starting to look a bit "stretched," valuation-wise.

Now what

I cannot disagree. Square reported a terrific sales quarter this week, no two ways about it. And yet, the fact remains that Square has lost money in four out of the last six quarters (including both quarters so far this year), and that it's free cash flow, which looked so good in years past, has turned decidedly negative in the face of the COVID-19 pandemic.

At 222 times trailing earnings, and something like 1,150 times trailing free cash flow, "stretched" is the nicest thing you can say about Square stock's valuation.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Square and recommends the following options: short September 2020 $70 puts on Square. The Motley Fool has a disclosure policy.

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