More money will be spent by U.S. consumers making online purchases this year than ever before. Adobe Analytics, which analyzes data from 80 of the top 100 U.S. online retailers, estimates that $7.5 billion was spent online this Black Friday, an increase of 20.5% year over year.
This is a trend that will only keep growing as merchants continue to augment their logistics infrastructure to ensure they maintain a robust online presence. In the third quarter of 2019, domestic e-commerce sales rose to $154.5 billion, a 16.9% increase year over year, while total U.S. retail sales only grew 4% over the same time frame, according to the U.S. Census Bureau. Two of the best companies for investors to take advantage of the growing e-commerce trend are Shopify (NYSE:SHOP) and PayPal (NASDAQ:PYPL). Let's take a closer look to see if we can determine which of these growth stocks is the better investment.
The case for Shopify
Shopify enables small and medium-sized businesses to sell merchandise across multiple channels (e.g., social media sites, online marketplaces, proprietary websites, and even brick-and-mortar retail locations) with a single, integrated back-office solutions package that includes analytics, marketing, payments, and shipping. The company's platform allows smaller merchants to maintain their identity without getting lost in a sea of other sellers in large online marketplaces and to focus on their core competency without getting bogged down handling the tedious tasks behind the scenes.
Shopify earns its revenue through two segments: subscription solutions and merchant solutions. Subscription solutions is the higher margin of the two and consists of the subscription fees merchants pay every month for access to Shopify's platform. In the third quarter of 2019, this segment grew to $165.6 million, which represented a 37% increase year over year. Merchant solutions consists of the extra services sellers can add to their Shopify subscriptions, including shipping, payment processing, and securing working capital. In Q3, merchant solutions grew 50% to $225 million.
The company's offerings have obviously resonated with its customers, as Shopify now has over one million merchants across its platform and, incredibly, captured 4.7% of the U.S. market share in e-commerce sales in 2018. In Q3, its gross merchandise volume (GMV) -- the total amount of goods sold across its merchant network -- soared 48% to $14.8 billion. This rapid growth and large total addressable market certainly don't come cheap. The company is still not profitable and shares trade at a price-to-sales (P/S) ratio over 25.
The case for PayPal
While PayPal also offers payment processing solutions to merchants, it generates the bulk of its revenue by making e-commerce easier for consumers. The company's One Touch platform enables consumers to register a device, such as a smartphone or tablet, and allows them to stay logged into their PayPal account, saving their payment and shipping preferences. Users can complete future online checkouts with just "one touch."
Consumers love this feature because it allows them to speedily complete purchases without the need to hand over their payment and personal identification information to a host of merchant websites. Merchants love the feature because sales conversion rates are much higher with customers who use PayPal than other forms of payment methods. In Q3 2019, 172 million consumers and 13.8 million merchant PayPal account holders had registered with One Touch.
PayPal now has 295 million active accounts, including over 23 million merchants, creating a real network effect, meaning that the more users that join PayPal's platform, the more valuable it becomes. As more consumers join, the more merchants will see the need to accept PayPal as a payment method at their checkout. The more merchants that accept PayPal, the more consumers will be incentivized to join.
In PayPal's third quarter, revenue rose to $4.38 billion, a 19% increase year over year, while adjusted earnings per share (EPS) grew 5% to $0.61. However, if PayPal's results had not been affected by unrealized losses in its strategic investments, its EPS would have grown by a much more robust 31%. Over the trailing 12 months, the company posted $2.94 in EPS, giving the stock a price-to-earnings (P/E) ratio of 36.7.
Shopify and PayPal might be the two most dynamic and growing companies poised to benefit from the rise of e-commerce in the years ahead, and both have long runways for growth. Shopify is increasing revenue much faster than PayPal and has a much smaller market cap, giving it more room to grow. That being said, PayPal is still growing revenue at a double-digit rate with a proven and profitable business model and a much cheaper valuation. For that reason, I believe PayPal is a better investment today.