PayPal Holdings (PYPL -1.96%) delivered a solid finish to 2021, but it issued a softer outlook for 2022 that sent the stock crashing. Lower earnings, along with lower guidance for customer account growth, didn't sit well with market participants, who have gotten used to PayPal delivering consistent revenue and profit growth over its history.

Let's review what influenced management's lower near-term guidance, and why the stock might be undervalued at these levels.

Two people using their mobile phones.

Image source: Getty Images.

Customers are using their accounts more

A glance at the guidance shows a lot to like. Excluding payment volume from eBay, which is transitioning to its own payments system, PayPal expects adjusted revenue to increase between 19% and 21% in 2022. Total payment volume excluding eBay should increase between 21% and 24%. These numbers are close to the levels PayPal achieved through 2019. 

But after adding 49 million net new active accounts in 2021, management expects to add only 15 million to 20 million this year. Some of the lower guidance is based on difficult year-over-year growth comparisons against the stimulus checks in early 2021, which boosted last year's growth somewhat. 

Moreover, management announced it was shifting its strategy away from trying to bring in more customers. Instead, it would lean toward growing revenue with existing users. This is where management believes they can add the most value to the business over time.

Looking at the recent quarter, it's easy to see why management wants to shift its focus to growing engagement. PayPal's business still looks strong based on the increasing frequency customers are using their accounts. Transactions per active account grew 11% year over year in the fourth quarter. At 45 transactions per account based on a 12-month average, customers are now using their accounts almost once per week, and growth in customer engagement accelerated through the end of the year. 

A bar chart showing the sequential increase in customer transactions over the last year.

Image source: PayPal Holdings.

Transactions per account is a more important metric to focus on, as opposed to customer account growth, which the market seems to be worried about. Customers must sign up and make payments with their accounts for PayPal to earn transaction fees -- the source of its revenue. The new strategy should attract higher-value customers, and make PayPal a stronger business.

While the lower growth this year means PayPal will likely fall short of its 2025 revenue target of $50 billion, management still sees revenue growing at an annualized rate of 20% beyond 2022. 

PYPL Revenue (TTM) Chart

PYPL Revenue (TTM) data by YCharts

PayPal still has a massive growth opportunity

Based on management's forward guidance for 2022, the stock trades at 25 times free cash flow, which is expected to grow 20% to $6 billion this year. 

When the markets get crazy, investors should take comfort that PayPal still has a trusted and ubiquitous brand, and more than 70% of North American and European retailers accept PayPal and Venmo at checkout. That's a strong competitive advantage that will keep the business growing for a long time.

Remember, PayPal is operating in a massive $110 trillion commerce market, and it only has a 1% share of that market. For this reason, PayPal can bounce back, although it will have to keep up with emerging competition such as Robinhood Markets and Block that are investing to grow adoption of their respective fintech services, too.

PayPal is a well-entrenched incumbent, though, with 426 million active accounts and 34 million merchant accounts. The stock could still fall lower in the short term, but it should recover and go on to deliver better returns from the lower valuation level.