Unfortunately, COVID-19 isn't going away anytime soon. With effects from the pandemic an ongoing issue, the business world is undergoing monumental upheaval and change -- which translates into new opportunities for investors. Digital payments and e-commerce in particular have gotten a shot in the arm this year.
As the fourth quarter and the (hopefully) busy holiday shopping season get underway, here are three top stocks to consider in that department: PayPal (PYPL -1.53%), Etsy (ETSY 1.47%), and Target (TGT 0.60%).
1. PayPal and 2. Etsy: Digital payments and online shopping, a match made in heaven
Both PayPal and Etsy have been near the top of my buy list during the late summer months. Over that span of time, they've done a whole lot of nothing -- other than take a dip during the first half of September during a broader tech industry sell-off. I still think both are great buys anyway, however, in the fourth quarter and beyond.
Let's start with digital payments and mobile money movement app PayPal (and its subsidiary Venmo). Adoption of digital wallets has picked up pace in recent years as younger generations more accustomed to using online and mobile tools get jobs, start families, and otherwise start spending money. Pair that with the steady increase in e-commerce spending, a trend that should have legs under it for a long time. Shockingly, according to the U.S. Census Bureau, non-physical store sales were still only 16% of the retail total in 2020 through August (when excluding gas stations from the mix). So internet sales remain the minority.
If ever there was a confluence of events to benefit a business, this is it. PayPal has skyrocketed higher this year, and currently has a market cap of $230 billion. It's big, but I see room for it to become even bigger. It has the ability to disrupt the banking status quo, as well as the older vanguard of digital payments, Visa and Mastercard -- both of which have been dinged recently because in-person, card-present transactions have been deeply impacted.
And once COVID-19 is beaten and the world is able to begin returning to some semblance of normalcy, PayPal will be there too, as it is launching touchless payment terminals for physical stores. Still a smaller outfit than its older peers (and trade partners) Visa and Mastercard, I think PayPal could surpass both in importance and size in the not-so-distant future. At 42 times trailing 12-month free cash flow (revenue minus cash operating and capital expenses), this is a premium-priced stock -- but premium for very good reason.
Back to e-commerce specifically, Etsy also lies at the intersection of several trends: online shopping, consumer demand for variety and choice, and a self-employment boom created by the sudden mass layoffs related to the novel coronavirus. Benefitting from these tailwinds, Etsy stock is up even more than the 80% gain PayPal is sporting, notching a more-than-170% run so far in 2020.
Even after its massive run higher, though, the online retail marketplace for craftspeople still has a market cap of just over $15 billion. It isn't tiny anymore, but its size pales in comparison to those of juggernauts like Amazon (AMZN -1.90%) and fellow small biz and entrepreneur supporter Shopify (SHOP -0.13%). In fact, according to eMarketer research, Etsy doesn't even show up on 2019's top-10 U.S. e-commerce list (as measured by the value of merchandise sold) -- a list topped by Amazon, with Shopify and eBay in distant second and third, respectively.
Granted, those are last year's figures, and it's possible Etsy has moved onto that list. The company's revenue grew 137% year-over-year in Q2 2020 alone, with another 85%-to-115% advance predicted by management in Q3. The bottom line is growing at an even faster pace as the retail platform starts to hit a more profitable scale as it adds more sellers and buyers -- thus explaining the stock's epic rise.
Plus, Etsy ended June 2020 with $1.04 billion in cash and short-term investments and $803 million in debt. In August, it raised an additional $650 million in cash via new convertible debt notes. This stock also trades for a hefty 42 times trailing 12-month free cash flow. However, with plenty of room for growth, net cash on the balance sheet, and expanding profit margins, this is a top e-commerce stock headed into the final quarter of the year.
3. Target: E-commerce that doesn't start with an "A"
Maybe premium-priced stocks aren't your thing, but you'd still like to get in on the e-commerce frenzy. Big-box store Target might be the investment you're looking for. At 12.6 times trailing 12-month free cash flow, this is a value stock that reflects the fact Target is no longer a high-growth company. Rather, its game is primarily adapting with the times to ensure it remains relevant in another decade's time.
But where many traditional brick-and-mortar operations have struggled or outright failed to evolve in this new digital age, Target is thriving. To understand why, we need to rewind back to 2017. Target was panned by many in the financial community for embarking on an expensive revamp of its business. It realized it had two key assets: It's a big-box store, so shoppers can make one trip to get most of the items they need; and its real estate puts a Target store within a few miles of most Americans. What it was missing was the convenience factor e-commerce offers and a better way to utilize its physical store footprint.
Target thus set off to improve upon its digital sales capabilities, and it bought Shipt (which now handles its grocery and merchandise delivery) in December 2017. It made software and logistics investments to create more fulfillment options (like in-store pickup, delivery, etc.), thus allowing its stores to serve as fulfillment centers, rather than just retail outlets. And Target also doubled down on what it already did best: It created more exclusive brands in the lucrative home, apparel, and accessory categories.
It took a few years to pay off, but Target is doing quite well in spite of the pandemic because of its prescient decisions a few years ago. Its small e-commerce segment is booming, up 195% year-over-year in Q2 alone -- leading to 25% and 80% increases in revenue and net income, respectively. And while the U.S. Census Bureau says retail sales in the clothing and apparel, home furnishings, and electronics industries are all down double-digit percentages this year, Target is bucking the trend. CEO Brian Cornell said that apparel sales grew by double-digits in Q2 (reversing a 20% decline in the first quarter), and beauty, home decor and kitchenware, and electronics sales grew by 20%, 30%, and 70%, respectively. Touché, Tarjay.
Amazon often gets the blame for the demise of many traditional retailers -- especially department stores with their ongoing woes -- but Target is doing its fair share of upending the retail experience as well. It isn't the most exciting stock around (don't expect recent growth rates to continue indefinitely), but it looks like a real value for the incremental growth and profitable gains it is generating right now. Headed into holiday shopping season, I see more market share consolidation in store for Target.