Headwinds and High Valuation Should Make You Skittish on Square Stock

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With Square (NYSE:SQ) likely to face tough competition from PayPal (NASDAQ:PYPL) in coming quarters and Square stock trading at a very high valuation, I would avoid buying Square at this point.

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Moreover, Square’s business is likely to continue to face tough headwinds for much of 2021. There’s a chance that Alphabet’s (NASDAQ:GOOG,NASDAQ:GOOGL) Google Pay, in the wake of a revamp of that app, could also hurt Square.

“Looking ahead to mid-2021, though, PayPal could move ahead of Square in the digital wallet race, lifting PayPal stock,” Investor’s Business Daily warned recently.

Specifically, PayPal intends to improve its “Venmo mobile app for smartphones and the PayPal app,” while adding its Honey coupon app to those two offerings.

A Closer Look at Square Stock

“With the wallet re-design, PayPal will be more full-service than Cash App,” Investor’s Business Daily quoted MoffettNathanson analyst Lisa Ellis as saying. PayPal’s Mobile Cash and Venmo apps are now the second-and-third most popular financial systems on Apple (NASDAQ:AAPL), with Square holding the top spot.

Another problem for Square’s Cash App may come from Google Pay, which is currently ranked fifth on Apple’s finance-app list. Piper analyst Christopher Donat recently warned that Square and PayPal may be hurt following a revamp of Google Pay

According to Donat, the downloads of Square’s Cash App increased roughly 12% year-over-year in December, well below the 80% YOY surge that the app registered in April. The analyst kept a neural rating on Square stock and an overweight rating on PayPal.

Square’s Seller App Likely to Be Pressured

A Seeking Alpha columnist recently warned that “Growth on Square’s Cash App side is what is currently supporting the company as the Seller side faces a lot of challenges from the COVID-19 pandemic.”

Making a point that I’ve raised in the past, the author points out that many small businesses could fail, stunting the growth of Square’s Seller business.

Moreover, he notes that Morningstar analyst Brett Horn has warned that, due to a number of factor’s, including its high prices, Square’s Seller business is vulnerable to competition.

With some large states looking to close small businesses again in recent weeks, thousands of such businesses could fail in the weeks and months ahead, putting additional pressure on Square’s Seller unit.

 The Bottom Line on Square Stock

Square has many positive attributes, including its first-mover advantage on the Seller side and its huge total addressable market (TAM).

The company has estimated that it has a TAM of $160 billion. And given the many additional financial services that Square could add and the tremendous size of the global banking market, I think that Square may be underestimating its TAM.

Still, Square stock has a market capitalization of nearly $100 billion, and its shares are changing hands for more than eight times analysts’ average 2021 sales estimate for the company. Consequently, I think the shares already reflect most of the growth that the company is likely to deliver, in a best-case scenario, in 2021 and 2022.

But the best-case scenario may not materialize. PayPal and Alphabet, which are both gigantic, highly capable companies, could take meaningful market share from Square’s Cash App, even as the latter firm’s Seller unit is hurt by cheaper competitors and macro issues.

If those negative scenarios do take hold, Square’s growth could slow meaningfully in 2021, casing SQ stock to underperform the market.

In light of the stock’s high valuation and the sizeable risks that Square is facing, I recommend that investors wait for the shares to drop to $180 or less before buying the stock.

On the date of publication, Larry Ramer did not have (either directly or indirectly) any positions in the securities mentioned in this article. 

Larry Ramer has conducted research and written articles on U.S. stocks for 13 years. He has been employed by The Fly and Israel’s largest business newspaper, Globes. Larry began writing columns for InvestorPlace in 2015. Among his highly successful, contrarian picks have been Roku, solar stocks, and Snap. You can reach him on StockTwits at @larryramer.

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