PayPal (PYPL -0.19%) stock has steadily moved higher since it broke away from eBay in 2015. The growing popularity of e-commerce and digital payments have driven PayPal and other financial tech stocks higher in recent years.
PayPal is entering a new era as it completes its separation from longtime parent eBay. Since splitting off in 2015, it has made critical acquisitions and started lines of business that should continue to increase revenue. Given the PayPal ecosystem and the growth of the fintech industry generally, PayPal stock could trade at significantly higher levels five years from now.
Its P/E ratio of around 59.2 may seem slightly elevated compared to the S&P 500 average P/E ratio of 25.4. Still, with earnings growth expected to average 19.17% per year over the next five years, most will find it difficult to not like PayPal. Three critical factors will likely help PayPal keep growing its business.
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1. The trend toward a cashless society
Society is increasingly turning away from cash. While I remain skeptical that it will go away completely, e-commerce and its convenience ensure the growth of digital payments. According to Grand View Research, the digital payments market is forecasted to grow at a compound annual growth rate of 17.6%, reaching $132.5 billion by 2025.
Considering this predicted growth rate, it's little wonder that analysts project so much earnings growth over the next five years. This could not only benefit PayPal, but also peers such as Square (SQ -1.33%), Visa, Mastercard, and others heavily involved in the digital payments market.
2. PayPal working to improve user engagement
Venmo has served as a critical part of PayPal's user engagement. It offers a platform by which users can both spend and collect money digitally.
In the fourth quarter of 2019, Venmo processed $29 billion in total payment volume (TPV), a 56% increase year over year. In 2017, Venmo saw $35 billion in TPV for the entire year! That speaks to the growing popularity of this app. As of the fourth quarter of 2019, Venmo had over 52 million active accounts. This likely remains well ahead of Square's Cash App, which has not revealed user numbers since it reported 15 million monthly active customers at the end of 2018.
Though PayPal initially struggled with the monetization of Venmo, the company has added features to earn revenue from the digital payment app. For instant transfers, Venmo charges 1% of the total transfer with a $0.25 minimum. The Venmo debit card and Pay with Venmo also take a small percentage of each transaction. Furthermore, in 2019, PayPal partnered with Synchrony Financial to offer a Venmo credit card, which should serve as another revenue source for Venmo.
Another part of user engagement has been PayPal's purchase of Honey Science. PayPal has stated a goal of getting people to use its site every day. This was one big reason behind this $4 billion acquisition. The app will help people track the prices of items as well as alert them of coupons as they become available. The company also plans to integrate Honey Science with both its Venmo and PayPal platforms. This should give users less incentive to switch to Cash App or other competing products.
3. Moves into foreign markets
As of December, PayPal completed its purchase of a 70% stake in GoPay, a provider of mobile payments in China. This gives the company a segue into the world's most populous country. By investing in GoPay, PayPal became the first non-Chinese company granted permission to provide online payment services inside the People's Republic.
By no means will it be easy for PayPal to enter China. It still lags Alibaba's (BABA 0.22%) Alipay and Tencent's (TCEHY 1.49%) WeChat Pay. Still, gaining access to the market at least offers PayPal an advantage over non-Chinese competitors. China represented less than 10% of revenue in 2019, according to PayPal's annual report.
PayPal also invested $750 million in Argentinian online marketplace company MercadoLibre (MELI -1.39%). This agreement offers PayPal access to the largest online and payments market in Latin America. It is also significant as Latin America remains largely a cash-based society.
PayPal's alliance with MercadoLibre could help change that. Thanks to this partnership, MercadoPago users in Mexico and Brazil can receive remittances directly into Mercado Pago wallets.
Should I buy PayPal?
The decision to buy this stock (or not) rests in the hands of the investor. Despite the benefits it offers, the company will continue to face challenges. It remains unclear how PayPal will compare to other payment ecosystems five years from now.
As of now, Square remains much smaller in both size and payment volumes. However, it has grown at a much faster pace than PayPal in recent years. Moreover, its ecosystem covers areas such as payroll and business loans, and it may yet succeed in obtaining a bank charter, which could fundamentally change the industry. Moreover, Venmo will have to fend off the direct challenge posed by Square's Cash App. While the company has improved its ability to monetize Venmo, it appears that PayPal has merely copied many of Square's monetization strategies.
Further, Venmo faces competition from Apple Pay. Apple Pay recently reported a run rate of 15 billion transactions per year. This exceeds Venmo, which recorded 12.4 billion transactions in fiscal 2019. It may explain why PayPal added the features from Honey to enhance Venmo's offerings.
Geographically, its success outside of the developed world is far from guaranteed. PayPal may have gained entry into the Chinese market. However, that factor alone will not ensure its success. Unfortunately for PayPal, many describe this market as a "two-horse race," due to Alipay and WeChat's collective dominance. Moreover, with these two payment ecosystems now open to international transactions, another potential niche closes for PayPal.
Latin America also remains challenging as it is more attached to cash than other parts of the world. How much progress PayPal has made in luring Latin Americans away from cash is not yet known. MercadoLibre's valuation saw a writedown in Q3 due to unrealized losses, though it benefited from an unrealized gain in Q4.
In the end, investors should stay focused on the aforementioned 17.6% compound annual growth rate. PayPal will have to stay on top of industry trends to capture some of that growth. Still, if the company can remain a force in this industry, it should raise the odds of PayPal stock trading at higher levels in 2025.
