When an individual stock moves sharply on what is generally a fairly quiet day, there is usually a good reason. Yesterday for example, Chili’s parent company Brinker International (EAT) reported earning that missed expectations, causing the stock to lose well over ten percent, and GameStop (GAME) did even worse, losing over twenty-seven percent after abandoning their plan to sell the company.
In the circumstances, both of those moves make sense, but there was another big drop yesterday that is harder to explain.
The payment network company Square (SQ) doesn’t report earnings until late February and, as far as I can tell, didn’t issue any earth-shattering statement yesterday, yet the stock lost around ten percent.
The obvious reason, and the most stated one, is a downgrade by Raymond James analyst John Davis, who set a target price of $56, about twenty-six percent below Monday’s close.
Now Raymond James, with over 7,000 financial professionals and over $600 billion under management, is clearly a force to be reckoned with and I’m sure Mr. Davis does excellent work there, but essentially this is a ten percent drop in the stock based on one person’s opinion.
There are twenty-nine firms that currently have a rating on SQ, and only two have a sell rating on the stock. Fourteen have it as a hold or equivalent, while thirteen have it as either a buy or a strong buy. Davis’ opinion counts, but shouldn’t the opinion of the eleven other analysts who have SQ as a “strong buy” count for something too?
Even if you believe that one analyst to be the guru when it comes to this stock, what he actually said was not that bad. His rationale for adjusting the target price was that Square may not grow as fast this year as it has in the past due to slower organic growth. For a stock that is essentially valued on growth that is obviously important, but one should bear in mind that that slowing would be from a rate of 117% in the last reported quarter.
The fact is, a drop like this on one opinion tells us more about the volatility of the stock than it does its prospects. SQ jumped over 150% in the first three quarters of last year, then led the charge down in Q4, dropping around fifty percent as the S&P 500 lost under twenty percent. It has a “beta” of 3.87, meaning that it tends to move nearly four times as much as the broad market indices. It is, essentially, a trader’s stock right now.
That means that any move is easily exaggerated as there are a bunch of itchy trigger fingers out there. When those holding the stock have a short-term view, any move down will prompt other sellers fearful of seeing their profits disappear. That, however, doesn’t tell us anything about the intrinsic, long term value of the stock or the company.
For that, we should look at the fundamental prospects of the company and the trajectory of revenue and earnings, and in both respects SQ appears to be in a good place. As I wrote in these pages back in August of 2016, when the stock was around $12, Square is not some futuristic tech company with an obscure product or concept, waiting for the world to catch up to its technology.
It is “old school tech,” a fairly simple product designed to meet a specific need for small businesses. That need still exists, and the customer loyalty that I predicted in that piece would come from meeting it is now evident in the 117% organic growth mentioned above, and an overall year on year quarterly growth rate of over 50%.
Ultimately, what counts is turning a profit on that growing revenue, and here too things are looking up for Square. Twitter (TWTR) CEO Jack Dorsey is also in charge at Square, and he of all people should know the importance of turning growth into profit. Once they started to do that at Twitter, earnings increased quite rapidly, with EPS going from $0.08 in August of 2017 to $0.21 in their last release.
Square is in a different business of course, but it would be no surprise at all if the same thing happened there given Dorsey’s experience.
In the past, Square has typically beaten expectations for revenue growth, both back in 2016 when those expectations were generally on the lower side and more recently as analysts have caught up to the reality. Those more realistic forecasts make the kind of spectacular beats we have seen in the past unlikely, but if expectations are just met the future for SQ looks bright and yesterday’s drop looks like a needed correction on the way up and an opportunity to buy the stock at a discount.