What happened
Investment banker BMO Capital raised its price target on point-of-sale payments processor Square (SQ 2.10%) 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?
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.
