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Much like other high-flying tech stocks, digital payments leader PayPal (NASDAQ: PYPL ) has struggled during the October stock market selloff. At its lows, PYPL stock had dropped nearly 20% from its recent highs of early October.
But this market is starting to show signs of life again after a string of positive tech earnings reports, headlined by Facebook (NASDAQ: FB ), and that is good news for PYPL stock. PayPal recently reported its third-quarter earnings, and they were much better than expected. PYPL stock popped in the wake of the news. But most of the gains were wiped out by broader market weakness and negative sentiment towards tech.
But if that sentiment reverses, PYPL stock could pop and regain its post-earnings highs.
In the big picture, PYPL stock is a long-term winner supported by secular growth trends in digital payments that aren't going away anytime soon. As a result, this company has a very robust long-term outlook, and has enough scale and reach at this point to largely fend off any competition. Consequently, the only things that could derail PYPL stock are a recession or an overstretched valuation.
I don't think we are going to have a recession soon. And the valuation of PYPL stock after this most recent correction is very reasonable. As a result, barring a Black Swan event, PYPL stock should climb from here.
The Outlook of PayPal Stock Is Robust
PayPal is a global digital payments leader with broad exposure to the secular shift from physical to digital payments.
Judging by PayPal's numbers, this shift is happening very quickly and showing no signs of slowing. Last quarter, PayPal's revenues rose by over 20%. Its total payment volume climbed 25% and its active accounts were up 15%, while its payments per active account jumped 9%. Finally, payment volume through Venmo, the company's mobile person-to-person payments app, soared nearly 80%.
All those growth rates are in-line with what PayPal has reported over the past several quarters. In other words, none of its metrics is really slowing down. Every single important growth metric remains robust, and that highlights the strong growth of the digital payments space.
Looking forward, the company's growth should remain robust for a long time. PYPL stock is a pure-play on the digital payments revolution, and the digital payments revolution is still relatively nascent and undeniably will be the future of commerce.
Most consumers still haven't fully embraced digital payments (only 10% of them have already loaded credit card information into a mobile phone or an app to make a purchase). But there is demand for such services, as 31% of consumers say they are likely or definitely likely to use them. Moreover, usage of digital payments is growing, with the number of consumers who have used their phone instead of payment cards to make a purchase having risen from 39% in 2015 to 51% in 2017.
Clearly, this transition has a lot of momentum. At the same time, it is still in its early stages. That is an attractive combination which implies that PayPal will grow rapidly for a long time.
The Valuation of PayPal Stock Is Attractive
Global consumer spending reached about $35 trillion last year, and PayPal's total payment volume came in at around $450 billion. That means PayPal controlled just 1% of the total global consumer spending market last year.
That is a very small portion. When you consider that PayPal is one of the few major players in the digital payment space, and that digital payments continue to grow in popularity, it is easy to see that PayPal's share of the total global consumer spending market should grow from 1% in 2017 to at least 2% or higher over the next five years.
Let's say global consumer spending hits $42 trillion by 2022. Let's also say that PayPal nabs 2.5% of the market. In such a scenario, PayPal's total payment volume would reach $1.05 trillion. Revenues historically run around 3% or slightly lower of total payment volume. Thus, TPV of $1.05 trillion should translate into roughly $30 billion of revenue.
PayPal's operating margins should rise to about 25% by then. That would produce $7.5 billion of operating profits. Assuming a tax rate of 18%, the company's net profits would reach $6.1 billion in five years. That should equate to earnings per share of about $5.
Historically, payment operators, including Visa (NYSE: V ) and Mastercard (NYSE: MA ), have a price-earnings ratio of about 25 times their forward earnings estimates. A 25 forward multiple on $5 of FY22 projected EPS implies a FY21 price target for PayPal stock of $125. Discounted back by 10% per year, that equates to a FY18 price target for PYPL stock of just over $90.
Thus, in the $80's, the valuation of PYPL stock remains reasonable, based on moderately optimistic growth assumptions.
The Bottom Line on PYPL Stock
The near-term weakness of PayPal stock is the result of valuation concerns and broader market turbulence. Both those headwinds appear to be moving into the rear-view mirror. As a result, PYPL stock looks ready to bounce back.
As of this writing, Luke Lango was long PYPL and FB.
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