When compiling a list of the most influential fintech companies, PayPal (PYPL -1.26%) ranks with the best. While the company has gone through several iterations, it's still a payment stalwart with brands like Venmo and Honey under its umbrella.
However, none of this has stopped PayPal stock from sinking like a rock over the past year. Since setting a record high last July, shares are down nearly 70%.
This drop was caused by multiple issues like poor management projections and digital tailwinds evaporating. Yet PayPal is still one of the largest payment processors in the world. So is this the new normal for PayPal, or is it due for a rebound?
A fairly typical quarter
PayPal reported its second-quarter results, and there were no new developments to send the stock soaring higher. Total payment volume (TPV) was up 9% year over year to $340 billion, and revenue echoed that rise by growing 9% to $6.2 billion. PayPal reported negative earnings per share (EPS) this quarter, but that was due to one-time tax charges and unrealized investment losses. However, free cash flow was up 22% year over year.
Also announced were PayPal's cost-cutting initiatives, which are expected to save about $900 million in 2022 and $1.3 billion in 2023. To me, this is one of the biggest announcements of the quarter. PayPal's management seems to be embracing the idea it is no longer a company that can generate massive top-line growth, so it's shifting its focus to expenses to optimize the business.
These efficiencies will also allow management to expand its operating margin going forward and return capital to shareholders, which it is doing in the form of share repurchases. In the second quarter, PayPal repurchased $750 million of stock and only paid its employees $326 million in share-based compensation, down from $401 million in the prior-year period. The ramp-up of share repurchases coupled with the decline in stock-based compensation demonstrates management's commitment to increasing shareholder returns.
Looking ahead to the third quarter, PayPal expects its revenue to grow 10% year over year and to return to GAAP profitability. While this guidance didn't blow anyone away, it reflects the new reality of PayPal's business.
The new reality for PayPal's shareholders
PayPal is shifting to a model to of steady, modest growth with a generous capital return program, which has worked well for both Visa and Mastercard. These three charts demonstrate that:
If you pull out the COVID-19 quarters and subsequent rebound, all three companies have grown at a similar 10% to 20% rate over the past several years (PayPal was spun off from eBay in 2015). However, both Visa and Mastercard were persistent about reducing share count too.
This consistent repurchase activity helped Visa and Mastercard outperform PayPal in the market, especially now that the latter has fallen from its peak levels when the stock was laden with lofty expectations.
PayPal's business isn't changing a ton. Management is just coming to terms with what the company has become and now understands what the limits of its platform are. This is still a high-quality business, but it's unlikely to become your portfolio's next ten-bagger.
With the company's cost-cutting efforts, share repurchases, and steady growth, PayPal can make a great purchase for any investor -- if you're willing to hold it for at least three to five years. The stock is still relatively cheap at 23 times free cash flow (compared to Visa at 29 and Mastercard at 39), so investors aren't paying a hefty premium like they did last year.
PayPal can still be an outstanding holding -- just don't expect it to generate massive returns in the near term. But it can still steadily outperform the broad market over a long time horizon.