PYPL

2 Reasons to Keep Paypal on Your Watch List

The last few years have been difficult for PayPal Holdings Inc.'s (NASDAQ: PYPL) investors as they witnessed a massive contraction in PayPal's stock -- the price fell close to 80% from its peak of $309 .

Although existing investors are understandably frustrated, potential investors have compelling reasons to pay attention to this leading fintech. This article will highlight two of those reasons.

Customer thinking about making an online payment.

Image source: Getty Images.

PayPal is hugely profitable

One of the biggest struggles that PayPal has faced over the last two years is its lackluster growth. For perspective, one of PayPal's key performance indicators (KPI), the active accounts, peaked in the fourth quarter of 2022 at 435 million and has since declined to 426 million a year later.

Even though the total number of payment transactions continued to grow during this period thanks to existing customers performing more transactions over time, the growth rate has declined from 34% in the first quarter of 2021 to just 13% in the fourth quarter of 2023. Understandably, revenue growth fell to just 8% in 2023, down from 22% and 17% in 2020 and 2021.

While growth investors are disappointed, savvy investors highlight a few crucial points the former might have neglected. To start, PayPal is enormously profitable thanks to its asset-light business model. For instance, it generated $5 billion in operating income in 2023, a 17% operating margin over a revenue base of $29.8 billion.

And since it doesn't require much capital investment for growth, the bulk of those profits became available for distribution to investors as dividends or share buybacks. In fact, PayPal spent over $12 billion in the last three years on share buybacks.

Besides, even though the tech giant's revenue growth has slowed in recent quarters, it still grew its top line by 8% in 2022 and 2023 thanks to the stickiness of its business model. For example, transactions per active account grew every quarter over the last three years, up from 42.2 per annum in Q1 2021 to 58.7 in Q4 2023.

In other words, PayPal might have trouble finding new users, but existing users remain loyal to its services. If PayPal can continue to delight its existing users and hopefully find new ways to attract new users, it could continue to generate enormous profits, which can be used for even more share buybacks in the foreseeable future.

PayPal stock trades at a discount to its history

PayPal's weak growth in recent quarters left most of its ardent supporters (mainly growth investors) disappointed. It wouldn't be surprising that most of them have sold their stocks in the company.

Still, the negative sentiments toward PayPal's stock bring one huge advantage: a lower entry price point for future investors. As of this writing, the stock has a price-to-earnings (PE) ratio of 16.1, which is a massive discount from its five-year average of 49.4.

The bears highlight that PayPal's stock deserves to trade at a lower valuation (compared to the past) since the company has been growing at much lower growth rates in recent quarters. If PayPal cannot resume its historical growth trajectory, there is no good reason to expect the valuation to revert to its historical levels.

Still, it's important to remember that almost every company faces challenging periods occasionally. So, while PayPal has faced enormous challenges in growing its user base in recent years, thanks to a growing number of alternative payment tools such as Apple Pay, Cash App, Shopify Pay, and Stripe, it could still adapt and bounce back. To this end, the company has brought in a new CEO determined to get PayPal back on a profitable growth trajectory. And let's not forget that despite all the complaints, PayPal still served a massive 426 million active accounts in 2023!

If PayPal can find its ground and rekindle growth, there is a possibility that investors might bid up the stock price to a higher valuation. Even if they don't, the growth in its underlying business will naturally lead to higher share prices, assuming that PayPal's valuation stays at current levels.

What it means for investors

Paypal is a leading fintech executing on its turnaround strategies to resume its past growth trajectory.

While a turnaround is never a sure thing, it's too early to write off PayPal since it's still one of the largest fintechs, with a vast customer base and a global presence.

Investors should give it a few more quarters as the new management team executes its plan. Considering everything, investors should keep an eye on this stock.

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Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends PayPal. The Motley Fool recommends the following options: short June 2024 $67.50 calls on PayPal. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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