Square (SQ) has been getting hammered recently, and it seems that despite the recent pullback, the valuation for the stock still appears high. Even when comparing the equity to many peers in the payment space, the stock is overvalued. It may be one reason why some traders have been betting the stock will continue to fall.
I first noted some bearish option betting taking place in Square on September 4. That was when the stock was trading around $61.20. I noted this in my SA Marketplace service Reading The Markets, Betting Square Falls. I have written on Square many times for the Free SA website in the past; you can track those articles and many more on this Google Spreadsheet I have created.
The stock isn't cheap and trades at a valuation that is much higher than payment processors, Visa (V), Mastercard (MA), and PayPal (PYPL). That difference isn't even small; it is by an extensive margin, based on a one-year forward PE ratio.
Square indeed offers superior earnings growth to those other companies. But the biggest problem I find with Square is that it continually disappoints when it comes to future guidance. The last set of quarterly results was just another example. I noted in a previous article that Square has consistently underwhelmed investors when it comes to that guidance. We can see based on future earnings estimates that those estimates tend to start high at the beginning of the year only to trend lower.
The underwhelming guidance may be one reason why the put option buyers are still coming after the stock. The options for expiration on November 15 saw their open interest rise by roughly 5,500 open contracts on September 13 to a total of approximately 11,700. According to data on Trade Alert, the options traded on the ASK, suggesting the puts were bought, a bet that the stock continues to fall from its current price of about $57.50 on September 13.
The put contracts trade for about $3.30 on September 13, and for a buyer of those puts to earn a profit, the stock would need to fall to roughly $51.70, a drop of about 9%.
The technical chart also shows that the stock is breaking down. The next significant level of support doesn't come until approximately $51.70, which by chance is the same as the options purchase.
The chart also shows that volume has been steadily rising in the last few trading sessions. That would indicate that the stock is seeing an increasing number of sellers.
The stock has already fallen sharply in recent days, and therefore there is the chance the stock sees a rebound. But at this point, if the stock does rise, it is likely to be limited. That is because resistance around $61 is expected to be very strong. That price had been an extreme level of support for the stock throughout August. What was strong support is likely to act as strong resistance once the stock breaks the support price.
Risks to Bear Case
The most significant risk to my bear thesis isn't likely to develop until the company reports results sometime around the middle of November. Should the company report reliable results, and issue better-than-expected guidance, it will reignite the bull thesis and help to rejuvenate the buyers.
However, there are many weeks between now and the next time the company will report results. Therefore the stock could continue to drift lower over the next several weeks, and if those put bets continue to pile up, it seems that the direction of the stock may only continue to lower.
The focus of Reading the Markets is to find stocks that may rise or fall using fundamental, technical, and options market analysis. Additionally, we search for clues from the broader markets to discover trends and gauge direction.
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Disclosure: I am/we are long V, MA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future results.