Markets

Should You Start Your War on Cash Basket with PayPal?

"The war on cash" is a phrase you often hear referring to the world's gradual shift toward electronic payments. Merchants and consumers have been taking advantage of new payment technology for years, but the trend has accelerated recently.

According to a recent survey by Mastercard, "The ways we pay for things has been changing more in the past 15 years than in the previous 150, and nearly every innovation we have seen has taken share away from cash." The pandemic has accelerated this trend, and within the next 10 years, some developed countries are expected to be entirely cashless. Currently, Singapore leads the way with 61% of payments being made without cash, followed by the Netherlands (60%), Sweden (59%), and France (59%). The United States is at 45%, and that percentage will continually increase. The trend is undeniable and could accelerate even faster as new disruptive technologies emerge.

As an investor, you look for trends that will sustain for the long term, and this is one of them. The stocks already in this space have seen meteoric growth in recent years, including PayPal Holdings (NASDAQ: PYPL). This digital and mobile payments leader should be the first stock in your war on cash basket. Here's why.

A person wearing protective glove paying with his phone while a person in gloves is holding a payment processing device.

Image source: Getty Images.

PayPal sees meteoric growth

You know PayPal -- it has become a household name over the years as more people use the platform to send and receive payments. The company has seen steady, consistent earnings growth over the past five years, but it really spiked in the second quarter to an all-time high.

PayPal saw earnings jump 85% year over year to $1.5 billion, or $1.29 per share, while revenue climbed 22% to a record $5.3 billion. Earnings spiked on a 29% spike in payment volumes, which refers to the amount of money that flows through PayPal's platform. Higher payment volume means more income, as PayPal makes money on fees every time the service is used.

The jump in payment volumes was largely related to the pandemic, as social distancing protocols led more people to engage in e-commerce. To that point, PayPal's Venmo service, which facilitates money transfers through an app, did $37 billion in total payment volume in the quarter, up 52% year over year. Venmo currently has about 60 million users, up from 50 million in 2019.

As a result, PayPal's stock price has skyrocketed roughly 90% year to date. It raises the question: Is this surge a function of the pandemic or will PayPal see continued growth?

Lots of free cash flow

PayPal will certainly continue to see continued growth over the next decade and beyond. It is the leader in online payments, with about a 55% market share -- far ahead of the closest competitors -- and it continues to expand its offerings. It is working on touch-free QR code technology for payments through PayPal and Venmo. CVS Health is the first retailer to sign up to use it and is expected to roll it out in the fourth quarter. PayPal also just recently launched the Venmo Credit Card, issued by Synchrony Financial. The Visa-branded Venmo credit card will have no annual fees and offers a cash-back feature.

New initiatives like these are made possible by the strength of PayPal's earnings and its incredibly strong capital position. In the second quarter, cash flow from operations grew 103% to $2.4 billion while free cash flow jumped 112% to $2.2 billion.

With that much free cash flow after expenses, it means the company is generating huge profits to invest. The operating or profit margin was up 170 basis points -- or 1.7 percentage points -- to 18.1% year over year in the second quarter. For 2020, PayPal anticipates 20% earnings growth, while analysts predict annual revenue growth of 23% over the next five years.

PayPal currently has about 346 million active users, and CEO Dan Schulman said earlier this year that his goal is to have 1 billion people on the platform. As the war on cash continues, PayPal will remain at the forefront.

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Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Mastercard, PayPal Holdings, and Visa. The Motley Fool recommends CVS Health and recommends the following options: long January 2022 $75 calls on PayPal Holdings. 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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