After a very brief market meltdown in March, many tech stocks have been off to the races in 2020 and continue to push to fresh all-time highs. It's becoming clear that the world will be forever changed by COVID-19, and the digital world will be more important than ever.
To that end, here are three top-performing digital stocks that still look like a buy in the month of September if you're a long-term buyer: Etsy (ETSY -2.17%), Visa (V 0.33%), and PayPal (PYPL 0.64%).
A supporter of digital entrepreneurship
Since the start of the pandemic and ensuing lockdown, Etsy has been one of my favorite e-commerce stocks. A month after second-quarter 2020 earnings, the online marketplace for handmade and unique goods remains a top e-commerce company to buy.
Through the first half of 2020, Etsy's gross merchandise value sold via its services grew 91% from 2019 levels to $4.04 billion. As a result, revenue (Etsy earns listing fees and provides other services to merchants on its platform) increased 87% to $657 million. Long a niche corner of the online retail industry, COVID-19 is turning Etsy into more of a mainstream destination for shoppers looking for creative items beyond what's offered at big box retailers. And in an age where it's easier than ever to start a business online, Etsy and a handful of other online technologists are championing digital entrepreneurship.
But why Etsy stock now, especially after shares have surged 172% so far this year? It all has to do with the bottom line. Etsy is reaching a scale where profit growth is increasing even faster than revenue is, with adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) up 130% through the first six months of 2020 to $206 million. Net income increased 119% to $109 million and was good for a net profit margin of 17% during the first half of the year. And with management forecasting another year-over-year 85% to 115% revenue increase in the third quarter, Etsy could find itself with plenty of new cash to invest in further expansion to keep its momentum rolling.
As of this writing, Etsy trades for 9.5 times 2020 forecast sales and just over 41 times trailing 12-month free cash flow. It's premium pricing, but well deserved as the world of e-commerce gets a big boost amid the pandemic.
Image source: Getty Images.
Digital payments on the mend
Closely related to e-commerce is the digital payments industry. A hot growth theme of the last decade, Visa and the other half of the digital payment network duopoly, Mastercard, had a rough go of things to kick off the 2020s. While online purchasing was a bright spot, most digital transactions take place in-person with a debit or credit card. And shelter-in-place and social distancing orders obliterated in-person transactions -- digital and cash.
As a result, Visa's revenue declined 17% to $4.84 billion during the spring months (Visa's fiscal 2020 third quarter, the three months ended June 30). Total payment volume took a 10% tumble compared to a year ago, and given the uncertainty in the global economy, any forward-looking guidance was withdrawn.
However, the good news is that processed transactions had returned to year-over-year breakeven by mid-July (although cross-border volumes remained down more than 30%). It will take time for Visa to return to overall growth, but a recovery is nonetheless being mounted. And even in difficult times, this remains a highly profitable company. Net income was $2.37 billion during the last quarter, good for a massive net profit margin of 49%. Come rain or shine, this is one powerful business model and explains why the stock is back to all-time highs in spite of what's shaping up to be a forgettable year.
Visa uses those lucrative margins to repurchase stock (about $900 million in the last quarter), pay dividends (currently yielding 0.6% a year), and invest in or purchase high-growth payment technology (like its takeover of Plaid). And with over $17 billion in cash and investments on the books at the end of June, there are plenty of opportunities for Visa to continue growing in the decade ahead. Shares trade for 40 times free cash flow, a metric that could get worse before it gets better in subsequent quarters as effects from the recession are digested, but nonetheless a worthy premium for the leader in digital payments.
Fintech is the banking future
Speaking of digital payments and financial technology, PayPal is also trading for a similar valuation to Visa (44 times trailing free cash flow) but is getting an outsized benefit from the pandemic. Where Visa and Mastercard rely heavily on in-person exchanges of money, PayPal has few problems in this regard -- its ecosystem processes primarily e-commerce purchases, along with mobile money transfers (primarily via Venmo).
In fact, while Visa is in contraction at the moment, PayPal is reporting an acceleration in its growth trajectory. Total payment volume surged 29% in Q2, leading to a 22% increase in revenue to $5.26 billion. Viewed through that lens, PayPal has actually become a larger company than its older card network peers Visa and Mastercard -- although it sports a much smaller market cap of $240 billion (to Visa's $450 billion and Mastercard's $360 billion). The reason? Lower profit margins.
Over the last year, PayPal's free cash flow profit margin was just shy of 29%, compared to margins of about 50% at Visa and Mastercard. But PayPal's investment in financial technology (especially Venmo) is starting to pay off in a big way. Free cash flow more than doubled from last year to $2.2 billion. Younger generations are increasingly relying on the mobile money movement app for purchases, for splitting bills with friends, and even outright using it as a normal checking account. PayPal continuously adds new features to its suite of services and is blurring the lines between software company and traditional bank.
Effects from COVID-19 are only hastening these changes in consumer behavior and making digital payments and e-commerce even more important. As effects from the late-March economic lockdown wane, it's looking increasingly likely that effects from the pandemic are going to stick long-term. This plays right into the hands of PayPal, and though shares are up nearly 90% so far in 2020, the stock looks like a reasonable value for investors looking many years down the road. It deserves consideration as a core portfolio holding as the economy goes digital.
