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2 Cheap Stocks With Tons of Upside

By Connor Allen – Jan 12, 2022 at 7:09AM

Key Points

  • Paypal’s new partnerships and their recent acquisition will help their business grow.
  • Lemonade’s latest acquisition opens up a new market opportunity.
  • Both stocks have fallen dramatically from recent highs.

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These stocks have positioned themselves to rebound from steep declines.

The market's major indexes have bounced back since their March 2020 lows, but many stocks within them still haven't. Great companies like Paypal (PYPL 2.04%) and Lemonade (LMND 6.56%) have been beaten down by unrealistic expectations and previously high valuations. Down 41% and 81% from their highs, respectively, here's why both stocks still present great buying opportunities. 

Paypal: Big partnerships and acquisitions 

Payment processor Paypal is best known for Venmo, which lets users send and receive money from their phones. The company makes money from transfer and payment fees for Paypal, Venmo, and "buy now, pay later" loans. 

But supply chain constraints worldwide have slowed down online shopping, and in its third-quarter earnings report, the company announced that it was scaling back its fourth-quarter revenue expectations as a result. This, plus lower-than-expected revenue in Q3, sent the stock tumbling to its lowest price-to-sales multiple since May 2020. 

A smiling shopper holding a credit card makes purchases on a laptop computer.

Image source: Getty Images.

But Paypal's Q3 also contained some good news. Over 75% of the largest global merchants now use PayPal at checkout. This integration, along with its vast network of 416 million active users, gives the company strong competitive advantages. And two key drivers could help the company grow even more in 2022.

First, Amazon – with its $450 billion-plus in annual revenue – will begin accepting Venmo as a form of payment at checkout at some point this year. Venmo has increased its customer base by 15 million users from Q3 in 2020 to Q3 in 2021. It is now as big on its own as Paypal's entire U.S. operations were in 2016. Being able to pay through Amazon could further increase Venmo's customer count this year. PayPal didn't provide any guidance about how this Amazon partnership might affect its top and bottom lines, but it will likely help Venmo's revenue grow from an estimated $900 million in 2021 to surpass the $1 billion mark in 2022. Venmo still has a lot of room for growth on monetization. It made up 19% of total payment volume in Q3 yet is only projected to make up 3.6% of the companies revenue in 2021. Paypal will need to find a way to help Venmo increase its overall revenue, not just its TPV. 

The company also announced some other key partnerships in Q3: Walmart, GoFundMe, United Airlines, Valero, and Phillips 66 are integrating their own checkout systems with Paypal or Venmo, solidifying Paypal's position in the market and offering many more opportunities for customers to use Venmo at checkout. It is still unknown as to what size of an impact these partnerships will have for Paypal, but it will be interesting to watch and see how they play out. 

Second, Paypal has acquired Paidy. This company leads the Japanese "buy now, pay later" market, which currently totals $10 billion with 38% annual growth expected through 2028. For $2.7 billion, compared to analyst estimates that Paidy brought in $66 million in 2021 revenue, the acquisition seems a bit pricey at 41 times sales. But Paypal seems willing to pay that steep price for a chance to grab some of the Paddy's vast market opportunity for itself.

Lemonade: New markets to conquer 

High-tech insurance upstart Lemonade provides fast and easy insurance quotes and claims using artificial intelligence. The company is adding customers; those customers are spending more money, even as the company raises premiums; and it's expanding into new markets. But investors' current skepticism of high-growth stocks, and their concerns about a recent acquisition the company made, have sent this stock spiralling. However, both of these bearish points turn into bullish points when you look toward the year ahead.

Many high-growth stocks got hammered in 2021 – but when you look at some of the valuation premiums people were paying for them, that plunge makes sense. At its peak, Lemonade was trading at greater than 100x sales. Now, it is trading at much more reasonable levels around 20x. 

For a company that grew premiums 84% year over year from Q3 in 2020 to Q3 in 2021, 20x sales is not a bad price to pay -- if it can continue this level of growth. The company's still-impressive premium growth rate has slowed down year over year in all three completed quarters of 2021. But Lemonade's continued expansion of offerings -- including auto insurance -- should enable the company to keep increasing revenue rapidly. 

Lemonade acquired auto insurer Metromile at the end of last year, and despite diluting existing shareholders to pay for it, it looks like the company got a great deal. Metromile has a decade-plus of valuable driving data and easy access to new customers. The $500 million in stock that Lemonade paid shrinks to around $200 million after you subtract the considerable cash on Metromile's balance sheet. 

Share dilution is never great as is normal in stock acquisitions, but the trade-off seems worthwhile: Auto insurance is a growing market expected to reach $1.06 trillion by 2027. Lemonade already offered auto insurance but had to navigate costly, time-consuming regulations to expand to new U.S. states. Metromile's done that work already, letting Lemonade skip the hassles and jump into lots of new markets quickly.

Acquiring Metromile and expanding into new markets may help the company's top-line revenue grow quickly, but management needs to find a way to increase the bottom line. For Lemonade, profitability remains years -- and likely many shareholder-diluting secondary offerings -- away. 

What to watch for next 

Neither PayPal nor Lemonade shares may rise in 2022 – but buying at these levels should pay off for patient shareholders years down the road. Sure, Paypal could experience slower growth this year, and Lemonade's stock could get cut in half again, but the fundamentals of these companies remain solid. 

Keep an eye on how Paypal's new partnerships affect their quarterly revenue growth this year, while keeping in mind that most of those deals don't go into effect until late 2022. For Lemonade, watch as the company utilizes its Metromile acquisition, and see how many states it can expand into with car insurance this year. Success on both these fronts could turn these two currently cheap tech stocks into long-term winners.

Connor Allen owns Lemonade, Inc. and PayPal Holdings. The Motley Fool owns and recommends Lemonade, Inc. and PayPal Holdings. The Motley Fool recommends the following options: long January 2022 $75 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

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