Shares of mobile payment processor Square (NYSE: SQ) have been on quite a run this year, having more than tripled year to date as the company continues to execute well and post solid earnings results throughout the year, successive guidance raises, and strong growth of gross payment volume (GPV). However, that rally has stretched Square's valuation metrics quite a bit, and shares now trade at over nine times sales.
Continue Reading Below
Given the gains, a pullback is hardly unexpected, and an analyst downgrade this morning has triggered just that. Investors are likely taking some profits off the table as a result.
Word on the Street
BTIG Research analyst Mark Palmer has downgraded Square shares from neutral to sell (price target: $30), citing a couple of key concerns. For starters, Square's valuation looks lofty at current levels. By Palmer's estimates, shares are now trading at 28.1 times his forecast for fiscal 2020's adjusted EBITDA ($610 million). Investors are now pricing in "emphatic and unimpeded growth" while not assigning proper weight to the risks that Square faces, according to Palmer.
Square will also have increased competition as it tries to expand its position with midmarket sellers (merchants that process over $500,000 in GPV annually). This group of merchants now represents 20% of Square's GPV, up from 11% two years ago. Square has historically been extremely popular with smaller merchants, but continues to move upmarket. As Square pursues larger merchants, it may need to make pricing concessions, which could hurt transaction margins.
The company is also taking on more risk with Square Capital, which provides loans to merchants. To highlight this credit risk, Palmer points to a $3.4 million charge that Square took in the third quarter.
Continue Reading Below
The bitcoin bubble
Bitcoin has experienced insane gains in recent months as the cryptocurrency pushes even deeper into bubble territory. Square recently confirmed that it was testing bitcoin trading in its Square Cash peer-to-peer (P2P) payments app. As a cryptocurrency, much of bitcoin's theoretical "value" lies in being able to actually use it to buy things from merchants that are willing to accept bitcoin (along with the inherent volatility risks to their own businesses). Oddly, Square's experiment does not allow users to transfer bitcoins or otherwise transact in bitcoins, only to trade it.
That news caused Square shares to spike even more earlier this month, as Square is now essentially piggybacking on bitcoin's hype, for better or for worse. Palmer argues that the bitcoin experiment will be immaterial to Square's top line even if it became a permanent feature, but the association with bitcoin could create incremental risk given bitcoin's incredible volatility and hype.
Even after today's drop -- shares are down 14% as of 2:20 p.m. EST -- BTIG's new price target represents nearly 30% downside.
10 stocks we like better than Square
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Square wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of November 6, 2017