What a year it has been for Square (NYSE:SQ) stock. Despite significant impact from the novel coronavirus pandemic, Square stock has been one of 2020’s big winners.
Specifically, the stock has gained 277% so far this year. It’s up more than six-fold from its lows in March, when the pandemic led to a wave of selling across the market.
I can see why more than a few investors might see the rally as a reason to sell. The sheer size of that rally suggests that SQ might have risen too far, too fast.
After all, Square has added an incredible $75 billion in market value this year alone. After the rally, Square stock trades at a huge, and seemingly unsustainable, valuation.
The price of SQ is more than 200x consensus earnings estimates for next year. Meanwhile, a return to pandemic-driven lockdowns would seem to be a short-term negative for the stock.
I don’t buy the skepticism. I’ve been recommending Square since the darkest days in March, and I’m still recommending it. There’s likely going to be some volatility, but as I’ve written before dips are a good thing. In this case, however, investors don’t need to wait for a pullback.
“Anchoring” Bias
I’ve written in the past about “anchoring” bias. In investing, anchoring bias most often plays out in the belief that a stock is “expensive” because it has run too far, or “cheap” after a significant decline.
Neither is necessarily the case. The stock market is dynamic. It constantly updates prices based on new information.
So, on its own, the 277% rally in Square stock doesn’t mean it is too expensive. It doesn’t mean the rally “has” to end, or is “due” to end.
And if there has ever been a market that shows the dangers of anchoring, it’s the 2020 market. Stocks that look expensive have usually kept rising. More often than not, stocks that look cheap have stayed cheap.
Understanding Square Earnings
I don’t believe that’s because the market is in a bubble, or because investors aren’t paying attention. It’s because investors are wisely prioritizing growth. There are so many industries set to post massive growth that could last not for years, but for decades. In an economy riding multiple megatrends, earnings multiples should be high.
Admittedly, that doesn’t mean SQ needs to trade at 209x the 2021 consensus earnings-per-share estimate. But it does mean that multiple, alone, doesn’t disprove the bull case for the stock.
Meanwhile, it’s worth considering what next year’s earnings estimates include. Square’s earnings are going to be depressed. Customers like restaurants and brick-and-mortar retailers are still going to see some pressure on their receipts, which in turn will pressure Square’s revenue and profits.
At the same time, Square is investing behind its business. Those investments are reducing near-term earnings, but will pay off over time.
The Case for Square Stock
Square’s underlying earnings power is far higher than 2021 estimates suggest. And there’s plenty of growth on the way. Square continues to have success attracting large customers. Cash App is driving increased adoption. It’s already nicely profitable, and has more room for improvement in terms of margins.
This is a transformative company in a sector that’s going to post enormous growth in coming years. The pandemic is only going to accelerate the existing move to cashless solutions. Square is a cryptocurrency play as well, and I remain a huge bull on bitcoin (CCC:BTC-USD) and other cryptos.
Yes, SQ stock has almost quadrupled so far this year. And yes, relative to next year’s earnings, the stock doesn’t look cheap. But it shouldn’t look cheap. This is a company that is going to grow for decades. It has enormous room to expand into new market segments. The potential from crypto alone has real value. And, again, next year’s earnings, at least using current Wall Street estimates, are somewhat depressed by the pandemic.
This is not to say that earnings and valuation don’t matter. Both do. But a single metric doesn’t prove that Square stock is overvalued. Given the company’s potential, the huge rally and the huge multiple both make sense. SQ still looks like a buy.
— Matt McCall and the InvestorPlace Research Staff
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Source: Investor Place