Shares of PayPal Holdings (PYPL -1.14%) have been getting clobbered over the past 10 months or so, falling more than 70% off all-time highs set in July 2021. While part of this has been due to the broad market sell-off all investors have seen lately, it was also because of a shift in strategy mentioned during the company's fourth-quarter earnings call in February. Management noted at that time that it planned to shift from a focus on monetizing users rather than just growing users and that concerned some investors.
The company's fiscal 2022 first-quarter earnings -- which were reported on April 27 -- showed the shift is having some preliminary success. The company is still increasing its user base, but the real highlight of the quarter was higher engagement. While the quarter had some flaws, it showed initial triumph in this new expansion strategy.
PayPal still has a lot to prove, but this sign of renewed life might be the signal to consider adding shares of this leading fintech platform to your portfolio.
Image source: Getty Images.
Why has PayPal stock fallen?
The shift from increasing customers to driving engagement spooked plenty of investors when it was announced earlier this year. The concerns were that it was unexpected and abnormal compared to the traditional growth that PayPal has focused on. For a long time, PayPal's success has primarily come from new accounts. Going into Q4, the company had expectations of reaching 750 million active accounts over the medium term, but it cut that guidance after announcing this shift.
That being said, there are benefits to focusing on expanding its user engagement rather than user count. Primarily, it can take a lot of investment to retain newer, low-engagement users. However, if management instead reinvested those funds toward boosting activity for its high-engagement users, the company could see a higher return on its investment.
In 2022, the company has been focusing on boosting activity for its users and especially its high-activity users. This should help the company become more profitable over the long term and generate a higher return on its investment. It should also decrease churn as users become more attached to PayPal's ecosystem of products.
The most telling figure
The strategic shift is just beginning but there are already signs it's working. In Q1 2022, the company saw transactions per active account (TPA) jump 11% year over year to 47. Management noted that the primary source of acceleration in growth over the coming year would come from this increased engagement.
Even with the change in focus, the company added about 3 million net new active accounts sequentially in Q1, so user growth is still going on.
The company plans to give investors average revenue per user (ARPU) figures in 2022, which will allow for better visualization of the company's strategy. While PayPal didn't provide ARPU this quarter, the TPA metric made it clear that the company is executing.
Not a perfect quarter
PayPal has some headwinds to get around. The company's revenue grew 7% year over year to $6.5 billion, but that was slower than the quarterly expansion rates the company has seen over the past few years. Additionally, PayPal saw a decline in both net income and free cash flow. For that quarter, generally accepted accounting principles (GAAP) earnings per share declined 53% year over year to $0.43. The company's free cash flow also sunk to $1.1 billion in Q1, which is a 32% dip from the year-ago period. On the bright side, that still represents a 16% free cash flow margin. Some of the declines are related to comparisons with quarters that were elevated due to the pandemic.
The company's guidance for the full year was nothing special either. Revenue is expected to grow 11% to 13% for the full year. Free cash flow is expected to be slightly over $5 billion in 2022, which is a decline from $5.4 billion in 2021. Again, both figures are in comparison to elevated figures related to the pandemic.
Should you buy PayPal?
Despite some of the lowlights in Q1, PayPal stock is worth buying today. One of the big concerns was how successful the company would be with this shift in strategy, and this quarter showed great first steps. While its cash flows and profitability might have been depressed, they are still impressive on absolute terms. There are plenty of companies that would do anything to reach 16% free cash flow margins, and PayPal achieved that.
At a valuation of 22 times free cash flow and 30 times earnings, PayPal seems abandoned by growth investors. However, this quarter showed that the company is anything but a has-been. While this isn't a dirt-cheap valuation, long-term investors could see this as a buying opportunity. Investors still need to make sure the company sees continual success with increasing engagement, but at these prices, it might be worth adding a few shares to your portfolio.
