Square stock will eventually move much higher, but do not buy it yet

<p>The Square (NYSE: SQ) stock has struggled in recent trading sessions. Weaker-than-expected third-quarter earnings, reported on August 1, sent the SQ stock up. In addition, fears of the total economy have put further pressure on equity.

Source: Shutterstock

But between these short-term battles, SQ has shown the potential to become the most transformative technology company since Netflix (NASDAQ: NFLX). Netflix destroyed video stores and blunted the growth of pay-TV. In the same way, Square ecosystems can be a tough challenge for both traditional and newer financial companies.

SQ stocks are likely to suffer for a shorter time

The inverted yield curve has raised fears of a recession. It has also left the market with many stocks that look appealing in the long run but can also hammer investors in the short run. Few stocks illustrate that dynamic better than the SQ stock.

The day after its earnings report on August 1, the SQ share fell 14% when the company delivered what some described as “easy earnings guidance” for Q3. Before the results were published, SQ closed at $ 80.98 per share.

I warned investors in mid-July not to buy SQ shares until they knew the shares could rise above the low $ 80s per share, which I thought was a potential cap. The upper limit contained, and now the SQ stock is about $ 65 per share.

After the recent decline, Square shares are traded at a price-to-earnings ratio (PE) of around 58. From a certain point of view, it does not seem expensive. Analysts predicted an average profit growth for SQ of 63.8% this year and 45.5% during the financial year 2020. Many investors would like to pay 58 times ahead for a stock that offered such growth.

However, the inverted yield curve may indicate that a recession is threatening, and recessions tend to reduce investors’ tolerance for such multiples. In addition, such conditions create concerns about profit growth. So far, analysts’ earnings estimates for SQ continue to remain stable. But in a recession, Square’s revenue would likely increase. For that reason, investors should probably not buy SQ shares now.

Square is set on transforming the economy as we know it

However, investors should look to buy SQ stocks as these fears begin to subside. SQ is on its way to becoming a payment ecosystem. In other words, it could be Apple (NASDAQ: AAPL) for the payment world.

SQ started as a company that allowed all smartphone users to accept credit card payments. The company has ventured into several payment-related companies to take advantage of the increased use of debit cards. Its innovations have presented a challenge for older payment companies such as NCR (NYSE: NCR) and automated data processing (NASDAQ: ADP).

In addition, its innovation can reach new levels if it receives a banking license. InvestorPlace contributor Ian Bezek rightly pointed out that becoming a bank creates a large regulatory burden for companies. But as we saw when Apple entered the music business, transformative companies tend to find a way around such difficulties. Due to the size and reach of Square’s ecosystem, a successful transition to banking can change the industry.

I do not think that SQ would drive all banks out of business if they get a banking license. However, this may lead investors to question the need for entities such as Citigroup (NYSE: C) or Goldman Sachs (NYSE: GS). And in such a scenario, SQ would at least force banks to transform in order to survive.

Final thoughts on SQ bearings

SQ stocks will fight for now, but eventually it will grow tremendously by transforming its industry. A high multiple for SQ shares, lower gains for SQ and a recession would put further pressure on the Square share in the short term. As a result, investors should look at Square shares, but not buy it right now.

However, the power of Square’s financial ecosystem continues to grow. This makes companies that only operate in part of the financial sector vulnerable. It can also make money-oriented IT companies or even banks as we know them obsolete. Although investors should stay out of the SQ stock for the time being, SQ looks ready to benefit from its transformation of financing as we know it.

At the time of writing, Will Healy had no position in any of the above shares. You can follow Will on Twitter at @HealyWriting.