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PayPal Holdings Looks Expensive. Is It a Buy?

By Dave Kovaleski – Updated Sep 4, 2020 at 9:42AM

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The online payments leader has a lot of room to run.

PayPal Holdings (PYPL -0.38%) has surged to all-time highs since the COVID-19 pandemic began, reflecting the major shift to online payments and commerce that has occurred worldwide due to stay-at-home orders and social distancing measures.

The company, which enables digital and mobile payments for consumers and merchants, has seen its stock price soar from its pandemic low of $85.26 on March 23 to its all-time high of about $211 per share as of Sept. 2. From the start of the year through Thursday's close, the stock price has surged 90%. Investors are certainly pleased, but has the meteoric rise been a function of the pandemic? And is the growth sustainable at its current price? Let's take a look.

A person holding a phone making an online payment.

Image source: Getty Images.

PayPal posts record revenue in Q2

PayPal crushed earnings in the second quarter, posting its best quarter ever. Earnings rose 85% year over year to $1.5 billion, while revenue climbed 22% to a record $5.3 billion. The earnings were buoyed by a 29% spike in payment volumes -- the amount of money that flows through PayPal's platform -- to $222 billion. PayPal makes money on fees every time the service is used.

PayPal's Venmo service, which allows people to transfer funds through a mobile app, provided a major revenue boost. Venmo did $37 billion in total payment volume in the quarter, up 52%. It has helped PayPal maintain its position as the far-and-away market share leader in online payments.

Furthermore, cash flow from operations grew 103% to $2.4 billion and free cash flow jumped 112% to $2.2 billion. The operating margin -- how much profit the company makes after expenses -- was 18.1%, up 170 basis points year over year. That much free cash flow means the company is generating huge revenue with low overhead and has lots of money to invest.

Sky-high P/E ratio

Since July 2015, when the company re-entered the public markets after spinning off from eBay, PayPal has seen quarterly revenue jump 221%, revenue climb 129%, and net new active accounts surge 522% to 21.3 million. And over the past five years, PayPal's earnings growth has outpaced its revenue growth. 

With its growth spurt, PayPal's price-to-earnings (P/E) ratio for the trailing 12 months has jumped to about 94 as of Sept. 3. The P/E ratio is the measure of a company's share price to its annual earnings per share. The average P/E for S&P 500 companies now is around 30, which is higher than its historical average in the mid-teens. Growth companies are going to be higher, but PayPal's P/E is extremely high. That's a sign of how much investors are willing to pay for its growth -- PayPal's forward P/E, which is based on projected earnings over the next 12 months, is almost 50.

So does that mean investor expectations are irrationally high and the stock is overvalued? Or does it mean that PayPal is poised to continue its strong growth?

PayPal is a buy

I think it's the latter and PayPal is a buy. While PayPal is facing growing competition in its space, it has been able to increase its market share, which is now about 55%, through innovations like Venmo. Now, it is working on deploying touch-free QR code technology for payments through both PayPal and Venmo. CVS Health signed on as the first chain to use PayPal and Venmo QR codes at checkout, which will be rolled out in the fourth quarter.

For the year, PayPal anticipates 20% earnings growth, and analysts predict annual revenue growth of 23% over the next five years.

The company is the market leader in a space that is only going to continue to grow as society gradually goes cashless, accelerated by the pandemic and social distancing protocols. CEO Dan Schulman said earlier this year that the goal is to have a billion people on the platform. PayPal currently has 346 million active users, so there is a lot of room for growth. And with its strong cash position, it will continue to invest in initiatives to get them there. So, yes, PayPal is expensive, but it's worth the price. 

Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends PayPal Holdings. The Motley Fool recommends CVS Health and recommends the following options: long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

Stocks Mentioned

PayPal Stock Quote
$73.94 (-0.38%) $0.28
CVS Health Stock Quote
CVS Health
$102.15 (-0.37%) $0.38

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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