We are finally at the tail end of a horrific year on Main Street. It has been the exact opposite on Wall Street because stocks are still setting new records despite all of this year’s madness. There have been tremendous winners and among them is Square (NYSE:SQ) stock, which we will discuss today.
Usually there is a small group of stocks that trade with a lot of momentum. When they rally, they do it so hard that it makes them impossible to buy with conviction. This year, that group is huge, including a slew of special-purpose acquisition companies (SPACs) in the electric vehicle sector. Just yesterday, we saw an explosion in them because of the rumor that Apple (NASDAQ:AAPL) wants to produce a self-driving EV by 2024.
Given all the general hype on the market lately, a key question arises for SQ investors. Is it appropriate to buy Square stock, even at these altitudes?
There isn’t one clear answer for all investors. The decision to buy a stock depends on several factors. The first is your timeline. How long you are looking to hold a stock will play a big role in the decision. If the goal is to invest in SQ for years, then it’s fine to buy a partial position now. A few bucks above or below are not going to matter much. Otherwise, this is not an obvious starting point for new buyers.
Square Stock Is Already a Super Star
Year-to-date it has already rallied over 280%, so the easy work is done. PayPal (NASDAQ:PYPL), which has also had a good year, is only up 125% for the same period. Square stock has outperformed its cohort by at least a double and is up 20 times more than the S&P 500. Such performance is hard to maintain for the short term.
Looking at the chart for SQ, we can clearly see an ascending channel with a steep slope. It is currently skirting the upper edges of it, so logic dictates that it should revert to the mean soon. This does not suggest that it will collapse because it has several lines of support along the way. It would be perfectly normal for it to fall 10% and still remain a very bullish chart. $220 per share would be the first available pivot point with another one $20 lower.
I would not expect catastrophe unless the entire market corrects. Even if it collapses, it would make for an unbelievable opportunity to initiate or double down near $185 per share. I am by no means calling for that price to happen all by itself. Management has worked hard at positioning the company right for the future. Square and PayPal quietly outsmarted the legacy credit card companies Visa (NYSE:V), MasterCard (NYSE:MA) and American Express (NYSE:AXP). They are quickly becoming the way people want to transact financially.
The novel coronavirus pandemic forced the world to seek electronic ways of transferring money while quarantining. Square was there and even made it possible for deposits to happen. Then bitcoin entered the fray with its incredible rally this year. Much to the chagrin of the naysayers, bitcoin broke through $24,000, crushing the prior high of 2017. Square has benefited from the rally because they have their finger on that pulse already. Any which way you slice it, this company is ready to take financial transactions to the next level. It can even create its own ecosphere for other business ventures in e-commerce.
Square Is Cheap
Most traditional investors see the ramp in a stock like this and immediately judge it as expensive. I contend that this is a perfect example of where value is in the eye of the beholder. This is absolutely a growth company because it almost quintupled its revenues in four years. Growth like this cannot come cheaply, so it’s okay for the company overspend. Besides, their net income went from a $172 million loss in 2016 to a trailing-12-months $311 million profit. I fail to see why critics find fault in that.
Statistically, SQ has a price-to-sales ratio of 15x, which is is four points higher than Microsoft (NASDAQ:MSFT) and nine points lower than Tesla (NASDAQ:TSLA). It is not outrageous by any means, even if the price-to-earnings ratio is 382x. Once again I stress the fact that “cheap” is not what investors should seek in a growth stock. Just ask those who shorted Amazon (NASDAQ:AMZN) for a decade on that notion. Shorting a high P/E for companies like this is a recipe for disaster for the bears.
Only time will tell if they’re worth the effort. Meanwhile, investors should give them the benefit of the doubt. We circle around to the original question if it’s appropriate to buy the stock now, the answer is yes. However, investors have to acknowledge the potential for 10% dips in such a steep rising wedge chart. Therefore, it is definitely not appropriate to take a full-sized position all at once. I would prefer to buy it on dips.
Leave Room for Error
If I use options, I can do that now and leave room for error. For example, an investor can sell the Feb $185 put and collect $2.5 per contract. This means that they would retain maximum profits even if the stock falls 25% from current levels. The break-even on such a trade would be $182.5 per share.
Buying shares in a stock requires homework, and a thesis. From those two elements, investors gain conviction. In this case, I am confident that if the markets are higher in the future, Square stock will be leading it. I am absolutely not confident that I would be picking the perfect entry point if I buy it today.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Nicolas Chahine is the managing director of SellSpreads.com.