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Square Stock Upgraded: What You Need to Know

Two hands tapping on Square input device and Square screen display

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

Shares of Square (NYSE: SQ) have nearly doubled since 2018 began, and are up almost three times over the past 12 months. The point-of-sale payments processing specialist turned in another terrific quarter last week, sending its shares up nearly 9% -- but within 24 hours, investors had already begun taking profits, and sold Square down 6% on Friday.

Was that the right call?

Two hands tapping on Square input device and Square screen display

Square Register. Image source: Square.

Upgrading Square

Buckingham Research doesn't think so. To the contrary, even after nearly tripling in value over the past year, Buckingham thinks Square stock still has more room to run.

This morning, Buckingham upgraded Square to buy and assigned the stock an $85 price target, according to a write-up on . Conceding that shares appear expensive (trading at 85 times forward earnings, according to data from Yahoo! Finance), the analyst explained that Square's "strong" results in fiscal Q2 justify the rich valuation.

S&P Global Market Intelligence reports that more analysts currently have hold or sell ratings on Square stock than rate it buy like Buckingham does. But despite what other analysts might think about the stock, Buckingham argues that Square has the ability to grow revenues "better than expected" through at least 2020. What's more, with adjusted EBITDA margins of 40% to 50% on its revenue, the analyst argues that even Square's 85 times forward earnings valuation isn't high enough, and that its growth and profits can "justify a higher valuation."

Do the numbers square up?

But do Square's own numbers "justify" such optimism? Let's take a quick look at the earnings results that sent shares up (then down) so much last week, and see if we can find a clue.

On Thursday, Square reported strong year-over-year growth in net revenue (up 48%) and adjusted revenue (up 60%). Gross payment volume over the company's network rose 30% to $21.4 billion, so its revenue is growing faster than its payment volume (a good thing). Square still isn't profitable, losing $6 million for the quarter, but that loss was barely a third of the $16 million it lost in the year-ago quarter, and the company's earnings before interest, taxes, depreciation, and amortization ( EBITDA ) nearly doubled year over year.

The company is also making bigger inroads with larger merchants. Clients running more than $125,000 a year through Square's network now account for half its business -- yet those larger businesses don't seem to be squeezing Square on transaction fees, because revenue is still growing faster than payment volume. The company also seems to be growing its installed base among customers rapidly, with hardware sales up 78% year over year. That should lay the groundwork for even stronger sales growth ahead.

Valuing Square

Result: Analysts who follow Square, on average, believe the company will grow its earnings at better than 61% annually over the next five years, according to data from S&P Global. Granted, it's hard to say how much weight to give that projection given that Square currently doesn't have any net profits. But S&P Global also projects that earnings will turn positive as early as next year, and its profits are expected to grow 17 times in size through 2022, when analysts forecast earnings per share of $2.05.

Admittedly, even taking this estimate at face value, this means that Square stock is currently valued at more than 33 times earnings...that it won't actually earn for four more years. That seems a rather optimistic valuation. Viewed another way, the stock is selling for 384 times the $73 million in positive free cash flow that it has actually produced over the last 12 months -- which also seems kind of expensive.

Buckingham seems to think that Square's growth rate may justify the heady valuation, and I'm inclined to agree. Still, that doesn't mean I'm comfortable with multiples this high. Great as the prospects look, and richly as it's rewarded growth investors to date, Square is definitely not a stock for value investors -- or anyone with a fear of heights.

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Rich Smith owns shares of Square. The Motley Fool owns shares of and recommends Square. The Motley Fool has the following options: short September 2018 $80 calls on Square and long September 2018 $55 puts on Square. The Motley Fool has a disclosure policy .

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.

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