Hey it’s Dan here. As I said a few weeks back, I’ve had Spencer Korek working with me on a few strategic projects as it relates to Risk Reversal. Below is a post that Spencer and I worked on where we look back at an interesting name that’s had quite the run this year.
As we come to the end of the year, let’s look at another “winner” of the pandemic: Square (SQ). At the start of the pandemic, SQ was thought to be in a difficult position given its reliance on small businesses. Now, however, the stock is up 240% on the year, and up over 500% since the March lows, sporting a market cap around $96 billion, above Goldman Sachs’ (GS) $92 billion market cap. Since making an all-time high a week ago near $243, the stock has barely seen an uptick, down 13% since, and with two trading days left in the year, we thought it made sense to drill down on one of the market’s best performers of the year.
SQ’s well-defined uptrend from its March lows was breached only once in early November (and even then for only a few trading days). Its shares then rose 60% to its recent highs. Near-term support comes at its intersection of the uptrend and its Nov breakout near $200, with very healthy support coming near the Nov lows just above $150, while the only real technical resistance comes near the recent high at $243:
Now let’s look at the fundamental setup. Just as with other names in this pandemic, we’ve seen an acceleration of consumer trends that SQ has benefited from.
SQ’s investment in its Cash App has paid off. Cash App’s revenue grew 573% from the quarter ended Sept 30 from 2019 to 2020, with gross profit on the Cash App growing 212% in the same period. Peer-to-peer payments aren’t going away any time soon post-pandemic, and SQ has added crypto trading, banking, investing, and other financial services to the Cash App, increasing the product’s stickiness. Jack Dorsey has been a long-time crypto bull and it seems that is now paying off. Back in October, SQ purchased $50 million worth of bitcoin. This is a rounding error in the context of the $2.1 billion in cash they have on the balance sheet but underlies their belief in crypto’s future. A few weeks after SQ’s announced purchase of bitcoin, payments peer Paypal (PYPL) caught up, announcing they would allow customers to buy, sell and hold crypto on their platform as well.
There’s also Square’s B2B subscription and services offerings for small businesses. It is many of these offerings that could have been seen as a drag during the March lows, but have turned out to be a lifeline for SQ’s business. These include Square Capital which helped facilitate PPP loans and could benefit from the next round of fiscal aid. This segment also includes team management, payroll, appointment schedulers, email and social media marketing, website design (they’ve owned Weebly since 2018), loyalty programs… the list goes on. They’ve started bundling these products together and are likely to continue to do so to increase their value proposition to small businesses and improve SQ’s ability to cross-sell.
In the quarter ended Sept 30, 2019, gross margins for the subscription and services-based revenue was 77% and constituted 43% of the company’s gross profits. In the quarter ended Sept 30, 2020, these numbers were an 85% gross margin and 48% of overall gross profit. The segment’s revenue grew by 60% while associated costs only grew 5%. With numbers like these, it explains the SaaS craze we’ve seen over the past few years in both public and private markets.
How to play the stock
If I’m a long-term investor looking to add to an existing position or initiate a new one, then I am very cognizant of the stock’s volatility and the many times in 2020 since its epic climb following its Feb/March 60% decline where the stock has presented significant dips to buy, seven of more than 10% from a then all-time high, averaging 18%. If the stock were to find support near the $200 level (the Nov breakout and the 50-day moving avg), that would mark an 18% decline, and possibly a good long entry point.
One of the main issues for fundamental investors is its valuation, trading 290x adjusted 2020 expected earnings and 190x expected 2021 adjusted earnings. On a GAAP basis, the company is expected to swing to an annual loss of 21 cents after posting its first year of profitability in 2019.
For existing longs who fear that the stock could face a wave of selling in the new year as those with gains look to take profits and fear that the company could face difficult comparisons in 2021 given the pull forward in demand during the pandemic, they may not want to sell but rather hedge their position. This would allow for potential upside, while still defining your risk in the position. You might want to consider a collar, by selling one out of the money call, vs 100 shares long and buying one out of the money put for instance…
Vs 100 shares long of SQ at $211 Buy Feb 190 – 240 collar for even money
-Sell to open 1 Feb 240 call at $7.75
-Buy to open 1 Feb 190 put for $7.75
Break-even on Feb expiration:
Gains of the stock up to 240, the short call strike, stock called away at 240 or higher, but long holder can always cover the short call to keep long stock position intact.
Losses of the stock down to 190, the long put strike, but protected below.
Rationale: for longs who don’t want to sell, but want to define their risk to the downside and are willing to give up some potential upside to do so, zero-cost collars make sense.