Several billionaire hedge fund managers were buying stocks as the market was plunging in the second quarter. For instance, Ray Dalio of Bridgewater Associates increased his stake in PayPal Holdings (PYPL +0.60%), while Ken Griffin of Citadel Advisors and Israel Englander of Millennium Management added to their stakes in Lululemon Athletica (LULU 2.96%).
Currently, PayPal and Lululemon stock trade about 72% and 36% off their highs, respectively. Is it time to buy these two beaten-down growth stocks?
NASDAQ: PYPL
Key Data Points
1. PayPal: A leader in digital payments
PayPal operates a two-sided payments platform, providing financial services to both merchants and consumers. Operating on both sides distinguishes the company from the vast majority of payment processors and gives it an edge. With data on both sides of the transaction, PayPal can more effectively prevent fraud, and it can drive sales for merchants by surfacing shopping deals for consumers who use its digital wallets.
On that note, PayPal is the most accepted digital wallet in North America and Europe, and it ranked as the most downloaded digital wallet worldwide in the first half of 2022. Better yet, its trusted brand boosts conversion rates by an average of 34% compared to other digital wallets, according to management. That value proposition helped PayPal win partnerships with many well-known businesses. Most notably, it recently struck a deal to power Shopify Payments in France, and Pay with Venmo will launch on Amazon later this year.
In spite of high inflation, PayPal delivered relatively solid financial results over the past year. Revenue rose 11% to $26.4 billion, and free cash flow climbed 8% to $5.2 billion. But investors should expect growth to accelerate in the coming quarters. The loss of eBay's business will cease to be a headwind in the second half of the year, and management says the company's operating margin will expand starting in the fourth quarter and continuing into 2023.
PayPal is focused on three product categories in which it has a significant competitive edge -- the PayPal and Venmo digital wallets, PayPal Checkout, and Braintree (a more customizable checkout solution designed for large e-commerce companies). That strategic shift is already paying off. PayPal continued to gain market share across all those categories in the second quarter, and revenue growth accelerated to 14% in July.
Management puts its market opportunity at $110 trillion, and PayPal stands to benefit greatly from the secular shift toward online shopping and digital payments. According to Juniper Research, digital wallet transaction volume will grow at least 60% between 2022 and 2026, or roughly 12.5% per year during that period.
Currently, shares trade at an inexpensive 3.9 times sales -- an absolute bargain compared to the three-year average of 9.5 times sales. That's why it's a great time to buy this growth stock.
NASDAQ: LULU
Key Data Points
2. Lululemon Athletica: A retailer with a premium brand image
Lululemon is a retailer of athletic apparel and accessories. Its reputation for premium-quality activewear has inspired considerable customer loyalty, and the company commands a significant amount of pricing power as a result. That success comes in large part from its expertise in designing technically advanced fabrics, though its direct-to-consumer sales strategy has certainly played a role.
Unlike many of its peers, Lululemon relies very little on wholesale channels, preferring instead to sell its products directly to consumers through its e-commerce platforms and company-owned stores. The company also tends to avoid promotions and price discounts, and that tight control helped it maintain its premium brand image.
Lululemon again delivered solid financial results over the past year, a particularly impressive feat in an economy hit by high inflation. Revenue rose 28% to $7.1 billion, and GAAP earnings soared 35% to $8.54 per diluted share. Better yet, the future looks bright for Lululemon, as management outlined an ambitious five-year growth plan earlier this year.
First and foremost, the company is targeting $12.5 billion in annual revenue by the end of 2026, which implies top-line growth of 13% annually over the next four-and-a-half years. To make that happen, Lululemon says it will double its men's business, double its digital business, and quadruple its international business. That optimistic outlook should encourage investors.
However, shares currently trade at a pricey 35.8 times earnings, a premium compared to peers like Nike and Under Armour, which trade at 26.4 times earnings and 22.4 times earnings, respectively. Of course, Lululemon is a high-quality business with significant brand authority, so it probably warrants a premium valuation. But I worry that consumers could pull back on discretionary purchases including premium athletic apparel if high inflation persists, and that could weigh heavily on Lululemon's profit margins, driving its price-to-earnings ratio even higher. For that reason, I think investors should avoid buying this stock until it trades at a slightly lower valuation.
