How to Approach Square Stock After Its Downturn

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Shares of Square, Inc. (NYSE: SQ ) enjoyed an undisturbed upward trend throughout the year and are now up nearly 200% in 2018. The advance came to an end shortly after Square stock price exceeded $100 per share at the start of October.

With SQ stock trading at around 14.5 times sales, markets are starting to question the stock's valuation. Visa Inc. (NYSE: V )  and  MasterCard Incorporated (NYSE: MA ) both trade for around 16 times their sales. But after Square stock suffered a convincing, strong, bearish drop of nearly 10% on Monday, Oct. 8, should investors stay away from the shares?

In its fiscal second quarter, Square earned 13 cents per share as its revenue jumped 60.1% year-over-year to $385 million. The company forecast total net revenue in the range of $3.19 billion to $3.22 billion. At its midpoint, that represents revenue growth of 55% versus last year. EBITDA will be in the range of $240 million to $250 million. Square has said that it would look to invest primarily in initiatives related to omnichannel, financial services, and international markets.

Since SQ reported its Q2 results in August, investors have been more upbeat about the payment service provider's growth prospects and bid SQ stock from $70 to over $100 by October. But as more macro headwinds emerge, momentum stocks like Square will drop first.

Mastercard and Visa are not faring much better. In the last week, those stocks fell by 4% and 3%, respectively. PayPal Holdings, Inc . (NASDAQ: PYPL ) is underperforming, too. Its stock, which had peaked at over $90, traded recently around $80.

Square's Strong Growth

Square will continue to grow at rates similar to those it enjoyed in Q2. The company's top line can keep expanding at a 60% rate,  but markets are valuing Square stock as if the company's execution will definitely be flawless. Expanding overseas, however, does carry some risks, especially in the midst of tariff battles and other hurdles.

Square's management did not issue guidance for fiscal 2019 or provide longer term targets. The company, however, has reiterated its longer-term margin target of 35% - 40%. Chances are good that it will meet or exceed that goal. Its payments business and its subscription services both have incremental margins of over 50%. The company's Cash App is an example of a development that will raise its profitability.

In the near-term, though, Square must invest in sales and marketing to drive its revenue higher. Those investments won't bear fruit immediately, and the company won't be profitable for at least three or four quarters.

The Relative Valuations of SQ Stock

Square stock does trade at valuations that are similar to those of PayPal, MasterCard, and Visa. Whether SQ deserves its current valuation is questionable. Already, Square stock, even after falling in recent sessions, trades near analysts' average $86 price target for the shares. Per Tipranks , analysts have 13 "buy" ratings and ten "hold" ratings on Square stock. Most recently, KeyBanc analyst Josh Beck rated SQ stock a "buy" with a $115 price target.

Finbox.io users have a different view on the fair value of Square stock. Based on the website's seven financial models, Square stock can drop by nearly 40%. By using the  Multiples Valuation: Revenue model, investors can compare Square's valuation to that of its competitors. Square's enterprise value/revenue multiples over the last year are frighteningly higher than those of PayPal, but they're not far from those of Mastercard and Visa. The valuation of Square stock suggests that investors think that the company is as diversified and as solid as those two credit card companies.

Source:  Finbox.io  (click on the link to crunch the numbers and calculate a fair value for Square stock)

The Bottom Line on Square Stock

There is a good chance that Square stock price will continue to fall as markets get nervous about growth plays. Square will no doubt beat growth expectations, but investors want the company to prove that its growth is sustainable. As tensions mount and markets weaken in October, consider avoiding SQ stock until the dust settles.

As of this writing, the author does not own shares of any of the companies mentioned.

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The post How to Approach Square Stock After Its Downturn appeared first on InvestorPlace .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Stocks
Referenced Symbols: SQ , V , MA , PYPL

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