Why Flat Trading Is Good for Square Stock

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Since a two-session, 20% plunge following second-quarter results on Aug. 1, Square (NYSE:SQ) stock has slipped another 4%. In fact, SQ stock nearly touched 2019 lows last month before a recent rally.

2 Big Reasons Why Beaten-up Square Stock May Rebound Soon

Source: Jonathan Weiss / Shutterstock.com

That trading hardly seems like good news. Indeed, I thought back in late August that SQ stock might rally sooner. Square stock had exhibited a pattern following recent earnings reports: an immediate selloff based on disappointing guidance, eventually followed by gains which were reversed by another post-earnings decline.

Given that Square clearly has established that its guidance is conservative, I thought the market might — this time — react accordingly. Obviously, that hasn’t happened.

But it’s why that hasn’t happened which is important. The lack of a rally might not be a sign of anything wrong with Square, or with Square stock. It might be a sign that investor support is holding around the $60 mark. If that’s the case, there’s a nice path to a rally — though investors need to keep the longer-term risks in mind.

SQ Stock Holds Up, Peers Don’t

Again, SQ stock has fallen about 4% in the last nine-plus weeks. That’s obviously not good performance on an absolute basis. But on a relative basis, it’s close to impressive.

After all, as I’ve noted recently, high-multiple growth stocks have been absolutely hammered over the same stretch. Shopify (NYSE:SHOP), which bears some similarities to Square, dropped 25% before a recent rally. PayPal Holdings (NASDAQ:PYPL) has fallen 11% after a more moderate 5% post-earnings decline in late July.

So-called software-as-a-service stocks have seen significant pressure. The BVP Nasdaq Emerging Cloud Index dropped 17% from July highs before a recent rally cut the declines to about 12%. The carnage has been worse in recent IPOs and unprofitable plays like Uber (NYSE:UBER) and Lyft (NASDAQ:LYFT).

Most stocks similar to SQ — stocks with big growth and multiples to match — have pulled back double-digits. SQ stock has done better, if not fantastically. Put another way, it could be much worse.

The Risks to Square Stock

To be sure, that alone doesn’t mean Square stock is due for a rally. Valuations across the space already looked stretched, and in some cases close to bubble territory. The declines of late may be a correction to more reasonable levels, not a pullback that is destined to reverse.

Market sentiment still looks a bit wobbly, with the trade war continuing and a contentious 2020 U.S. presidential election on the horizon. A recession still looms as a possibility, and Square, like Shopify, has a great deal of exposure to the small businesses that historically struggle in downturns.

And it’s not as if the pullback makes Square stock suddenly cheap. The stock still trades at 57 times 2020 consensus earnings per share. Analysts remain split on the stock. KeyBanc Capital Markets upgraded the stock on Monday, citing growth going forward. Wedbush and Evercore both have fretted about potential investments pressuring the bottom line. Indeed, I’m still somewhat skeptical given cyclical risks and valuation. From here, SQ stock, near $62, looks attractive but not quite compelling.

The Case for SQ

But growth stock investors may well see it differently. And this has been a market where, for a decade, growth stock investors have been the clear winners.

And there’s a nice growth case here. Square has an enormous opportunity to move up to larger customers and to expand its offering. The company conceivably could become an acquisition target at some point. Revenue is growing at a 40%+ clip this year and should rise 30%+ in 2020. SQ stock might not be cheap — but it’s cheaper, certainly, with 2018 highs right at $100.

For investors willing to take on the risks, SQ stock does look potentially attractive here. The one obvious near-term risk is the Q3 report, coming likely at the beginning of November. SQ has developed a worrisome track record in terms of post-earnings performance: Indeed, last year’s Q3 came in the middle of a three-month, 50% decline. 2019 trading hasn’t been any better.

There’s a case to wait and hope that Square handily beats the supposedly disappointing Q3 guidance and then sells off on worries about the Q4 outlook. Such a move would provide a better entry point.

Whatever the moves going forward, the moves going backward do look potentially helpful. For two months, this has been a market where stocks like SQ have seen significant selling pressure. Yet, save for a brief dip last month, Square stock has held up. That suggests that a good number of investors still see value at these levels. And it would seem to mean that if Square can keep driving solid growth, there’s a path to a rally when the ‘risk-on’ trade returns.

As of this writing, Vince Martin has no positions in any securities mentioned.

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