Markets

Should You Buy Square Inc (SQ) Stock? 3 Pros, 3 Cons

InvestorPlaceInvestorPlace - Stock Market News, Stock Advice & Trading Tips

Jack Dorsey's fortunes have diverged. His social media platform, Twitter Inc (NYSE: TWTR ) continues to lose large quantities of money. TWTR stock sits 75% off all-time highs and not all that far from new 52-week lows. However, Dorsey's other publicly-traded company, Square Inc (NYSE: SQ ), has moved in the other direction.

Why Square Inc (SQ) Stock Is Starting to Pick Up Its Groove

Source: Chris Harrison via Flickr (Modified)

SQ stock has rocketed back up after a bumpy 2016. Shares trade near new all-time highs. Analyst upgrades, a strong recent quarter and expansion of ancillary services are all getting investors excited. But, there are still plenty of risks in SQ stock. Should investors ring the register on this payments play now?

SQ Stock Cons

Jack Dorsey Is a Busy Man : There's a difference between being a great entrepreneur and a great executive. They seem like similar roles, but the needed skills are actually quite divergent. A business founder needs to have vision, see things others don't, find an untapped consumer need and deliver something creative to fill the void. There world needs great thinkers to solve these sorts of problems. Jack Dorsey is such a man and he's proven to have the vision for this sort of role.

However, once the company is off the ground, you have to switch into an executive role. And Dorsey has struggled with that previously. He was once forced out as Twitter's CEO. According to the book Hatching Twitter , Dorsey was a poor manager, focused too much on his hobbies, handled criticism poorly and sowed seeds of internal division. He eventually returned to Twitter, but the performance of TWTR stock has been less than impressive since then.

So, it's worth considering if Dorsey is fit to be Square's CEO. Additionally, Dorsey has plenty on his table (hobbies and other distractions aside). He is CEO of two large publicly-listed companies, along with being on Walt Disney Co's (NYSE: DIS ) board. It's a lot to ask from someone whose previous managerial work hasn't been particularly superb.

Credit Risk: The attraction of a business like Visa Inc (NYSE: V ) is that it takes minimal credit risk. Taking a cut of every payment that goes through, it's safe and stable. Square, by contrast, does not have such a low-risk model.

Yes, the company makes some money on payment processing, but not enough, it would appear, to be profitable. Instead, it is relying on ancillary services such as Square Capital to make the business model work. See the pros below. That's fine, but it comes with more operational risk. The sorts of companies Square lends to tend to fail frequently; most small shops or restaurants don't survive more than a few years. Square can diversify this, to some extent, across thousands of loans.

However, if the economy turns down, Square's loan performance would almost certainly suffer. Small business simply doesn't tend to be recession-resistant. Further, other Square services, such as the food delivery business, would likely suffer significant loss of momentum in a recession. Despite appearing diversified, Square has a lot of exposure to credit risk and the economic cycle.

SQ Stock Is Expensive: SQ stock is trading near all-time highs. SQ stock has briefly topped $15 on a few occasions, but has always fallen back. The stock appears to be making another technical double top off that level now. In the past, SQ stock fell from $13 to $9 following the IPO, then from $15 back to $9 last year. If it can't get past $15 this time, either, volatility could send Square stock lower in a hurry.

At today's price, SQ looks quite expensive, and it looks even worse the more you inspect things. As of the last filing, there appeared to be 352 million shares of outstanding SQ stock. However, add in all the stock options used for employee compensation, and the real share count balloons out to almost 450 million. The company is using stock heavily to pay employees.

SQ Stock Pros

Square Capital Is a Great Opportunity: A lot of negativity around Square is due to the fact that the payment-processing business is highly competitive and Square doesn't appear to be particularly profitable. Throw in the high-profile loss of Starbucks Corporation's (NASDAQ: SBUX ) business, and bears claimed Square was outmatched.

However, that misses what makes Square exciting. The real opportunity appears to be in lending, rather than making low-margin transactions for large companies. Square Capital allows SQ to lend to companies using its platform, with credit card receipts as collateral. Many of these loans are too small for most banks to touch. However, Square can lend on small amounts to many clients, spreading risk and offering a previously difficult-to-obtain service.

Square's lending volume is growing at a triple-digit rate, with more than 34,000 small businesses borrowing an average of $6,000. Even if processing payments is only marginally profitable, it gets Square into a position where it can offer high-profit-margin loans to businesses without many other options.

Pacific Crest Comments: Josh Beck of Pacific Crest sees a strong year ahead for virtually the whole payments industry. He called outperform for just about all the players, but he saved special praise for Square and Total System Services, Inc. (NYSE: TSS ), rating them as his top picks.

Specifically to Square, Beck views the company's small-business-based model as unique and "underappreciated." Notably, one of the few stocks Beck didn't rate favorably was key competitor PayPal Holdings Inc (NASDAQ: PYPL ).

Still Growing Quickly: Despite losing the Starbucks business, Square continues to grow quickly. Revenue continues to grow at a greater than 30% clip, and adjusted revenue, which takes out transaction costs, is climbing at an annualized pace faster than 50%. Revenue from software and data products is growing at an almost 150% rate. For all the talk of imminent competition, SQ hasn't lost its growth momentum, yet.

Verdict

I'm not inclined to go chasing SQ stock up near all-time highs. The stock has failed at the $15 level before, and we may be seeing it play out again. There are still real questions about management's capabilities, and the company is using excessive amounts of stock-based compensation, consuming much of the potential upside in SQ stock.

It's not all bad news, though; Square Capital could turn into a blockbuster business, and the even the company's core transactions business is still growing nicely. But, the risks outweigh the rewards at today's price.

As of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek .

More From InvestorPlace

The post Should You Buy Square Inc (SQ) Stock? 3 Pros, 3 Cons 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.


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

In This Story

PYPL TWTR DIS SQ

Other Topics

Stocks

Latest Markets Videos

    InvestorPlace

    InvestorPlace is one of America’s largest, longest-standing independent financial research firms. Started over 40 years ago by a business visionary named Tom Phillips, we publish detailed research and recommendations for self-directed investors, financial advisors and money managers.

    Learn More