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4 Critical Things You Need to Know to Understand PayPal's Earnings

By Danny Vena – May 9, 2020 at 12:22PM

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After missing expectations by a country mile, the stock was climbing. What gives?

Digital payment processor PayPal (PYPL 1.77%) released its first-quarter financial report after the market close on Wednesday. Net revenue grew to $4.62 billion, up 12% year over year, while earnings per share (EPS) of $0.07 declined 87%. Not much to write home about at first glance.

On an adjusted basis, EPS was slightly more palatable, coming in at $0.66. For context, analysts' consensus estimates were looking for revenue of $4.74 billion and adjusted EPS of $0.68, so PayPal missed on both the top and bottom line.

However, a look beyond the headline numbers reveals a much different picture, showing why PayPal stock is up 13% since the report.

Man scratching head and looking confused.

Image source: Getty Images.

1. A strategic loss

PayPal took a number of hits to its bottom line, one of which was related to its investment portfolio. Investors will recall that early last year, PayPal made a $750 million investment in Latin American e-commerce platform MercadoLibre (MELI 0.64%). As such, the company is required to report the gains or losses related to its strategic investments -- even though those are paper losses and have nothing to do with the operation of the business.

During the first quarter, MercadoLibre (like many, many other equities) fell due to the uncertainty related to the COVID-19 pandemic, losing nearly 15% of its value during the three months ended March 31. As a result of this decline, PayPal took a temporary writedown of $151 million, or $0.07 per diluted share.

It's important to note that the rule cuts both ways. As of this writing, MercadoLibre stock has soared over 75% since April 1, making PayPal's investment worth much more.

2. A negative accounting effect

Other accounting rules can also play into reported results, and that's exactly what happened during the first quarter. With the uncertain macroeconomic environment, PayPal was required by generally acceptable accounting principles (GAAP) to revisit estimates regarding the potential for loan defaults under the Current Expected Credit Losses (CECL) model.

As the result of its revised calculations, PayPal increased its credit loss reserves, which reduced operating income by another $237 million, or about $0.17 per share. Again, this is a paper transaction and has nothing to do with the running of the business.

3. A taste of Honey

PayPal revealed that it ended the quarter with 325 million active accounts, up 17% year over year, including about 25 million merchant accounts. This was driven higher by an impressive addition of 20.2 million new accounts during the quarter, but that number requires further explanation.

The company added 10.2 million active accounts with the completion of its acquisition of Honey, which closed in the first quarter. The company is best known for its discount-finding browser add-on, but it also offers a suite of other products and services, including a mobile shopping assistant, an offers and rewards program, and price-tracking tools and alerts.

However, even backing out those users that came courtesy of Honey, PayPal added a first-quarter record 10 million net new active users, driven by strong demand for both PayPal and Venmo. The company believes the strong user growth will continue and expects to add between 15 million and 20 million net new active accounts in the second quarter.

It's also worth noting that PayPal's EPS took a hit to the tune of $0.22 per diluted share for taxes related to the acquisition of Honey.

A spark and an arrow rising from a man's hand.

Image source: Getty Images.

4. Mayday -- no, in a good way ...

There were challenges in the first quarter, and management said that while PayPal's business was negatively affected by the global pandemic in March, it saw a dramatic improvement in transactions throughout the month of April. In fact, CEO Dan Schulman said: "I would argue that April was probably the strongest month for PayPal since we became a public company." 

Things turned even more positive this month. On May 1, PayPal had the largest single day of transactions in the fintech leader's history -- even beating out its performance during 2019's Black Friday and Cyber Monday.

This added context reveals that PayPal had a much better quarter than the headline numbers suggest. It also provides investors with a valuable lesson: It's usually worth digging into the results to get the full story.

Danny Vena owns shares of MercadoLibre and PayPal Holdings and has the following options: long January 2022 $75 calls on PayPal Holdings. The Motley Fool owns shares of and recommends MercadoLibre and PayPal Holdings and recommends the following options: long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

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Stocks Mentioned

PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
$85.75 (1.77%) $1.49
Mercadolibre, Inc. Stock Quote
Mercadolibre, Inc.
$804.69 (0.64%) $5.11

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