Why Square (SQ) Stock Should Be Bought on Weakness

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Since its debut on Wall Street back in 2015, payment processing firm Square Inc. (NYSE:SQ) has consistently delivered market-beating returns to its owners. However, its most recent quarterly results spooked the market, and SQ stock suffered a significant pullback as a result. Now Square stock is trading more than 35% lower than its 52 week high, making it an excellent time for the bulls to take a position in SQ. 

Should the dip in SQ stock be bought? Here’s a look at the arguments on both sides.

The Decline of SQ’s Core Business

Square Stock sq stock

Owners of SQ stock were understandably spooked when management offered less-than-desirable guidance for the current quarter. SQ expects its core payment-processing business to weaken, and it predicts that its payment-volume growth will continue to  slow. Analysts say that the latter development  could be a worrisome sign. 

The industry is getting increasingly crowded, and getting the attention of new merchants and holding onto it is becoming more and more difficult. With that in mind, the weakness of SQ’s bread and butter could be the beginning of a larger downtrend of SQ stock.

The Valuation of SQ Stock

On top of that, Square stock is expensive even after losing more than 30% of its value. As my fellow InvestorPlace contributor Ian Bezek pointed out, SQ stock is trading at almost 60 times analysts’ 2019 estimates and 7.5 times its 2018 sales.  That means Square stock is priced for high growth, and small setbacks have the potential to trigger big-time declines in SQ. That’s what happened earlier this month after SQ reported its Q1 earnings.

Growth Is Coming

While Bezek isn’t wrong about SQ stock’s sky-high valuation, bulls argue that the growth runway is huge for Square. While payment processing is the firm’s bread and butter right now, that won’t always be the case. SQ has gone from being simply a payment processor for small businesses to becoming a one-stop shop for merchants. Square has been tacking on extra offerings for years now, from inventory management and shipping to payroll and lending. Those extra services differentiate SQ from its peers, and make switching costs for merchants much higher because they already rely on Square’s ecosystem in order to run their businesses efficiently.

Of course, right now those additional services aren’t contributing much to the firm’s profits., so payment processing is still number one when it comes to revenue generation at Square. However, all of that could change soon if Square continues down its current path.

Lending Potential

SQ stock recently went from being simply a payment processor to offering loans as well. That initiative could greatly boost SQ stock. Square’s merchant data, which includes real-time transaction info, should help the company make better financing decisions than banks can. 

Merchants who might not be able to secure a bank loan may be able to borrow money from Square, since  SQ can use its data to determine whether loans will be risky with much more accuracy than traditional lenders. Plus, Square’s access to merchant transactions means the firm may eventually be able to collect  loan payments every time merchants makes a sale rather than when they decide to pay.

Square Capital, the company’s lending arm, is growing rapidly. During Q1, SQ facilitated $508 million in loans, a 50% increase from the previous year. 

SQ has also created a peer-to-peer payment platform called Cash App, which has also grown exponentially over the past year.

While Square still has a lot of growth potential in the payment processing space as cashless payments continue to gain momentum, investors should also be excited about the potential that Square Capital and Cash App offer. 

The Weakness of SQ Stock Is a Buying Opportunity

Naysayers say the valuation of SQ stock is too high, but I believe worries about the firm’s growth potential are overdone. SQ has done a good job of creating a differentiated experience for merchants, and the firm’s foray into lending could greatly accelerate its growth. For that reason, I believe the pullback of SQ stock is due to shortsightedness and could offer long-term investors an excellent entry point.

As of this writing, Laura Hoy did not hold a position in any of the aforementioned securities. 

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