If you have $1,000 ready to invest, I have 10 reasons why you should consider buying shares of PayPal Holdings (PYPL 0.64%). With PayPal's stock price hovering around $300 per share, I can already hear protests that $1,000 only lets you buy three shares (a little more if you buy a fractional share as well). Maybe you're tempted to find a cheaper stock so you can get more shares and make your dollars stretch further.
With stocks, it's helpful to focus on your rate of return, not how many shares you have. I'd rather earn a 20.75% annualized rate of return with 3 shares of PayPal stock than a 10% annual return with 100 shares of something else. Historically, a 20.75% return is a market-beating performance, and very few companies do it. But as we'll see, there are at least 10 reasons to believe PayPal stock indeed can.
Image source: PayPal Holdings.
1. Cash is diminishing in importance
When global behaviors shift, it pays to heed them. For years now, cash has become something we handle less and less, giving rise to the importance of financial technology companies (fintechs) like PayPal.
Even if you ultimately choose not to invest in PayPal, this is a global trend you can't ignore. You should at least invest in some company like PayPal. Life-changing value is being created by businesses operating in this space, and PayPal could be one of multiple winners. But I may be more bullish on this company than the others for the remaining nine reasons we'll see here.
2. Customer growth at 16% CAGR
When eBay spun it out in 2015, PayPal had 181 million accounts. It ended 2020 with 377 million accounts, more than doubling over that time frame and good for about a 16% compound annual growth rate (CAGR). This rapid growth reflects the trend we already noted and demonstrates PayPal's position as a top fintech.
PayPal's customer growth isn't over by a long shot. By 2025, the company expects to have over 750 million active accounts, roughly double where it is today. And much of this growth could come internationally, where there's still a relatively high percentage of cash transactions compared to digital. To seize international opportunities, the company has smartly forged key partnerships with companies like MercadoLibre in Latin America and Ant Group's Alipay in China to take market share.
3. Increasing customer engagement
Linear growth in a customer base is one thing. It's another thing when that growth is exponential, like PayPal's. That because users are more engaged with its services over time. In 2015, the average PayPal user made 28.1 transactions annually. Excluding the positive impact of its acquisition of coupon company Honey, PayPal users transacted 40.9 times in 2020.
One recent product that's increasing PayPal's customer engagement is Buy Now Pay Later. Since launching in October, the company has noticed a 12% increase in weekly spending from those using the service. In short, PayPal is clearly becoming more relevant.
The PayPal app. Image source: PayPal Holdings.
4. Future engagement potential is rising
PayPal's goal is for customers to use its services more and more, and it has multiple ways to drive future engagement. For example, the company plans to launch more services for cryptocurrency this year, allowing people to transact using Bitcoin. From the limited crypto services it already offers, management saw a 50% increase in daily user log-ins, showing just how expanding services for cryptocurrency could drive future engagement.
PayPal also plans to launch new services like stock trading and bill payments to get its users more engaged. And as that happens, it will not only increase its customer base, but the company will also likely generate more revenue from those users than ever before.
5. Revenue growth is steady
Because it's attracting customers and they're spending more over time, PayPal has superb revenue growth for a large-cap stock. From 2015 to 2020, revenue grew from less than $10 billion to more than $21 billion. But over the next five years, management expects revenue to exceed $50 billion, good for a CAGR of over 20% -- an acceleration from past growth.
Don't think that's realistic? Consider how relatively little volume flows through PayPal right now. In 2020, the company had $936 billion in total payment volume (TPV). Compare that to Mastercard, which had $6.3 trillion in gross dollar volume (like TPV, but it includes things like balance transfers). Comparatively, PayPal is still small and has room to grow as cash is continually replaced with digital transactions.
By the way, management's $50 billion revenue target doesn't include the positive impact of acquisitions. This is PayPal's organic revenue growth potential only.
PYPL Free Cash Flow data by YCharts. TTM = trailing 12 months.
6. Free cash flow growth is accelerating
PayPal shareholders should celebrate its revenue growth because of the company's impressive margin for free cash flow. In 2020, it had a FCF margin of 23%, comparable to its margin since separating from eBay. The company expects this performance to continue with over $40 billion in FCF over the next five years, and over $10 billion annually starting in 2025.
7. Share buybacks are a priority
With that much cash flowing in, PayPal's management has important capital-allocation decisions to make. Historically, it's rewarded shareholders with buybacks. It plans to keep doing the same, with 30% to 40% of FCF being used for future buybacks. Therefore, expect it to buy back between $12 billion and $16 billion in stock between now and 2025, which will help grow its earnings per share modestly.
Image source: Getty Images.
8. The potential for acquisitions
PayPal doesn't just buy back stock with its cash; it reserves plenty of it for acquiring other companies. Here's why you should embrace management's acquisition strategy: Many previous acquisitions expanded PayPal's total addressable market (TAM), like when it acquired iZettle in 2018 for $2.2 billion. This helped move PayPal beyond simply online purchases to also getting a share of much larger offline commerce channels.
Management still sees untapped market opportunities, like government payments and asset trading, so it will be interesting to monitor potential acquisition targets as its FCF expands dramatically in coming years. And as the TAM grows for PayPal, so too will the stock's ceiling.
9. A track record of benefiting multiple stakeholders
One place I like to look for investing ideas is Fortune's list of the 100 fastest-growing companies, which considers several factors such as three-year revenue growth, profitability, and stock returns. It's a good reference point to see which companies are delivering the best for their investors. PayPal ranked 78th on this year's list.
However, investors aren't the only stakeholders -- there's also the workforce. Glassdoor is a good third-party site to see how companies are doing in this area. It just released its 2021 list of the best places to work, and PayPal ranked 59th. Currently, 78% of employees would recommend working at PayPal to a friend, and 93% approve of the CEO.
For the record, PayPal was one of only three companies to rank on both Fortune's and Glassdoor's lists this year (Mastercard and lululemon athletica are the other two). So PayPal has one of the top track records, giving me great confidence it still has the right DNA to be a multibagger investment from here.
10. Winners win
Sustained business success doesn't just happen. More often than not, it's the result of an impressive market opportunity, a great business model, and savvy management. When a company has proved capable in the past, as PayPal has, it's hard to bet against it. Winners can continue succeeding for a long time.
Over the next seven to 10 years, given everything we've seen here, I wouldn't be surprised if PayPal was able to join a select few companies with a market cap of over $1 trillion. That would make this stock nearly a three-bagger from here and would most definitely beat the market. To me, this opportunity is definitely worth a $1,000 investment today.
