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Better Buy: PayPal Holdings vs. Discover

By Jon Quast - Jan 29, 2020 at 9:24AM

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Choosing which stock to buy comes down to your investing style.

As the war on cash makes digital payments an increasing part of commerce worldwide, both PayPal Holdings (PYPL -1.56%) and Discover Financial Services (DFS -0.30%) find their services in increasing demand. Each has processed billions more in payments in 2019 compared with 2018. And while I believe PayPal is the better buy today, either could be worth buying depending on individual investment goals.

uncertain man thinking

Image source: Getty Images.

If you want growth: PayPal

PayPal's primary business is to process payments online and collect a small fee for it. In the third quarter of 2019, the company reported outstanding growth in important metrics for this core business. Active accounts were up 16% year over year, to over 295 million. This double-digit increase led to both higher transactions and higher payment volumes. Transactions, a measure of each time money changes hands, were up 25%. Total payment volume, which measures the dollar amount transacted, rose 27%.

While its organic growth is stellar, the company is looking for something more. In its PayPal's Q3 2019 earnings call, CEO Dan Schulman said, "We are quite focused on growing our value proposition beyond checkout as our consumers look for more reasons to use PayPal as part of their everyday financial life." I see the company's recent $4 billion acquisition of Honey as a strategic step toward growing beyond checkout.

A shopping card on a laptop visually represents e-commerce.

Image source: Getty Images.

Honey supplies shoppers with the best discount code possible when checking out with certain merchants online. This is obviously a compelling reason for shoppers to become Honey users. But its services are also appreciated on the merchant side of the equation, as more leads are converted into sales. By acquiring the company, PayPal provides a valuable service for both consumers and merchants beyond just processing the transaction.

Also, while PayPal is already a global company, it's still looking to profit from the Chinese economy. To that end, it has been a busy couple of months. The company acquired a 70% stake in Chinese payment-processing company GoPay in December. In January, it announced a partnership with Chinese credit card company UnionPay. More than just China's largest credit card company, UnionPay is the largest such company in the world by payment volume, according to RBR. It's too early to put a dollar number on these moves. But PayPal now has a leading position in the race to profit from the world's second-largest economy. 

If you want stability: Discover

I consider PayPal a growth stock, and growth stocks can be hit harder than average stocks in a bear market. Seasoned investors know that this comes with the territory in bear markets, and the next one is a matter of when, not if.

If the possibility of PayPal falling hard in a market downturn is too much to take, you might consider Discover instead. Going back to the bear market of 2008 through 2009, Discover outperformed the rest of the market, even though returns were still slightly negative.

DFS Chart

DFS data by YCharts.

Discover included several encouraging items in its already reported full-year 2019 results. Diluted earnings per share (EPS) increased 16% from 2018 to $9.07. Net income lagged EPS growth, at 8%. EPS growth doubled net income growth thanks to shareholder friendly actions by Discover's management. In 2019, it paid out 77% of earnings to dividends and share buybacks. 

But not everything is rosy for Discover; there are two reasons for concern. The first regards the net charge-off rate (the amount of past-due loans that the company likely won't collect on). This crept up to 3.17% in 2019, has crept up every year since 2015, and is forecast to reach 3.3% to 3.5% in 2020. The second issue concerns upcoming operating expenses in 2020. The company is guiding to invest $4.7 billion to $4.9 billion in technologies that will help it stay relevant in a quickly changing payments landscape. Investing in itself is smart, but it's a sharp 8% to 11% increase year over year in operating expenses. 

These concerns explain why Discover's stock was down around 10% post earnings, and down around 20% from 52-week highs. But considering the company is returning a lot of cash to shareholders, and it trades at just eight times earnings, now may be a great time to get to buy a company that has more than doubled the return of the S&P 500 over the last decade. 

The better buy

Personally, I prefer the kind of growth PayPal is delivering. Full-year results are due out on Jan. 29, when it's expected to report revenue of $17.7 billion at the midpoint of its guidance (up 92% since 2015 and 15% year over year). EPS growth, however, is expected to outpace revenue growth. Management is guiding for 18% to 21% EPS growth, and aiming for around 20% annually. 

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Stocks Mentioned

Discover Financial Services Stock Quote
Discover Financial Services
DFS
$97.68 (-0.30%) $0.29
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
PYPL
$73.24 (-1.56%) $-1.16

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