How Risky Is PayPal Holdings Stock?

PayPal Holdings (PYPL 1.94%) and its digital wallet subsidiary Venmo just knocked another quarterly earnings report out of the park. Revenue and adjusted earnings per share increased a respective 23% and 29% year-over-year during the final months of 2020. The pandemic has benefited PayPal, as the world has been forced further down a digital path, and the company sees further double-digit percentage growth in 2021. 

In spite of the stellar growth figures, though, PayPal stock trades for a hefty 68 times full-year 2020 adjusted earnings per share. How risky would a purchase of the digital payments leader be at this juncture? Not nearly as risky as the premium price tag might lead some investors to conclude. 

Image source: Getty Images.

Lots of new users in the digital banking ecosystem

By all accounts, PayPal had a blockbuster year. The company added 72.7 million net new active accounts in 2020 (bringing the total up to 377 million at year end), and total payment volume (TPV) grew 31% from 2019 levels to $936 billion, adjusted to negate foreign currency fluctuations. Within the total, peer-to-peer digital wallet app Venmo processed $159 billion in TPV, up 56% from 2019. Venmo ended the year with just shy of 70 million active accounts.

The resulting financials for the last full-year period are impressive:

Data source: PayPal. 

The big takeaway here is that as PayPal adds more users and activity to its payment platform, its profitability is rising at an even faster rate. With its infrastructure already paid for, incremental additions to revenue are nearly all profit. This shows up in the big year-over-year jump in free cash flow, which includes PayPal's heavy spending on new projects to foster further expansion. Given management's outlook for about 19% revenue growth in 2021, the even faster pace of profitability expansion explains the high earnings multiple PayPal trades for. On a one-year forward basis, the stock trades for a somewhat more reasonable 47 times expected earnings.

A long-term play on e-commerce

But is PayPal still worth buying given the premium price? I say yes -- if you plan on holding for a couple years or more. PayPal is a great bet on booming e-commerce. It's rolling out new QR code scanners with brick-and-mortar stores to grow its presence in the physical world as well. While digital payment network peers Visa (V 0.81%) and Mastercard (MA 1.13%) are bets on a rebounding economy -- especially in physical retail and travel -- PayPal is getting a lift from online spending, and is poised to benefit if it can make inroads into the card-present retail realm. 

Put another way, as the world adapts to a new digital-first reality, PayPal is spending aggressively to become a top-of-mind payment option among consumers, and adding plenty of new merchants to its payment acceptance ecosystem. In fact, PayPals apps are increasingly encroaching on the traditional banking industry. Users averaged just 41 transactions over the last year, up just 5% from a year ago (when excluding the acquisition of Honey). If PayPal can start to grow the number of times users of its apps make payments, watch out. These efforts are still in the early stages of paying off on the bottom line. 

Given this dynamic, I think PayPal is actually a pretty good long-term value, not an "expensive" stock. Granted, this is a growth company, and so the share price will be volatile. But that doesn't make this a high-risk stock to own if you plan on holding for a couple years (the more the better) and plan to buy the inevitable dips.