Square Inc. (SQ, Financial) has been a tremendously popular stock with investors under the Covid-19 tech boom. Recent earnings have come out strong once more, and the payment processing company even beat its revenue estimates by $1.71 billion. Since its earnings release, the stock has gained an additional 12%, but I believe that an inflection point has been breached and future growth prospects are already priced in.
Financial inefficiency
There's been a disconnect between revenue growth and profit margins. The company has scaled tremendously, but hasn't been running an efficient business model, as reflected by the year-over-year growth shown in its income statement:
Adding to the concern for investors is the fact the company's return on equity has been lagging. An ROE of 6.25% lags the industry average of 25% by a significant amount. Furthermore, the flatlining ROIC indicates the competitive advantage is diminishing.
Issuing business still under pressure and bitcoin headwinds
Square isn't anticipating a recovery in its corporate card business and expects the corporate level to remain under pressure for the rest of 2021, which is a potential problem. In addition, prospective portfolio sales in a sensitive macro climate might be damaging to the company.
The rise of bitcoin transactions brought much-added optimism to the company's Cash App. The market seems to be slowly but surely returning to efficiency, so I anticipate retail bitcoin transactions will retrace significantly. Many investors bought Square stock with the hope of bitcoin sending the company's Cash App into another paradigm, which could've caused the share price to correlate with the currency during a tremendous bull run earlier this year. However, increasing headwinds in the cryptocurrency space are a cause for concern.
Multiples are overcooked
As shown in the chart below, Square's multiples are high in comparison to other players in the space.
Source: Morningstar
The price-earnings ratio of 321.89 is extreme even for a high-growth stock. Square is also trading over 7 times an acceptable price-sales ratio and over 50 times an acceptable price-to-cash flow ratio. Both of these metrics can be used throughout a company's lifecycle and are critical valuation indicators.
Moving on to growth prospects, the company might be doing well regarding investing in and growing its business model, but a PEG ratio of 4.61 means that the current stock price outweighs anticipated growth prospects by a wide margin.
Final word
I am by no means suggesting that Square is a short seller's dream. My argument is based on the stock's price reaching an inflection point where future growth is already priced in. Investors should start worrying about future earnings and the planned company shareholder policies from here on out, as that's what will determine the stock price moving forward. In a nutshell, the price will start moving after the fact as opposed to before.
