PayPal's (PYPL 0.10%) stock dipped 2% on Nov. 4 after it posted its third-quarter report. The digital payment service provider's revenue rose 11% year over year (12% in constant currency terms) to $6.85 billion, which beat analysts' expectations by $30 million. Its adjusted earnings declined 3% to $1.08 per share, but still topped estimates by $0.12.

Those growth rates seem stable, but a deeper dive into PayPal's numbers reveals three red flags that indicate it isn't a bargain yet -- even though it's already shed more than three-quarters of its market cap since last July.

PayPal's campus in San Jose.

Image source: PayPal.

1. Anemic growth in active accounts

Last February, PayPal declared it could nearly double its active accounts from 377 million in 2020 to 750 million in 2025. But its account growth subsequently slowed to a crawl, and it abandoned that target this February. The final stages of eBay's four-year transition from PayPal to Adyen, which finally concluded in the third quarter of 2022, likely exacerbated that slowdown.

Metric

Q3 2021

Q4 2021

Q1 2022

Q2 2022

Q3 2022

Active accounts

416 million

426 million

429 million

429 million

432 million

Growth (YOY)

15%

13%

9%

6%

4%

Data source: PayPal. YOY = year over year. 

PayPal expects to end the year with just 434 million to 436 million active accounts, which would equal about 2% growth from the fourth quarter of 2021. During the conference call, CEO Dan Schulman blamed that slowdown on a "challenging macro environment, slowing e-commerce trends, and an unpredictable holiday shopping season." That gloomy outlook isn't surprising, but competition from Block's Square, Stripe, and other payment platforms could be generating additional headwinds.

2. Decelerating growth in total transactions

Investors would probably be less concerned about PayPal's sluggish growth in active accounts if its year-over-year growth in transactions and total payment volume (TPV) were offsetting that slowdown.

In the third quarter, PayPal's transactions rose 15% year over year to 5.6 billion as its TPV grew 9% (14% in constant currency) to $337 billion. Unfortunately, both growth rates decelerated sharply over the past year:

Metric

Q3 2021

Q4 2021

Q1 2022

Q2 2022

Q3 2022

Transactions growth (YOY)

22%

21%

18%

16%

15%

TPV growth (YOY)

24%

23%

15%

13%

9%

Data source: PayPal.

It expects that slowdown to continue with just 8.5% TPV growth (12.5% in constant currency terms) in the fourth quarter. That slowdown indicates that the growth of Venmo, which now hosts 57 million monthly active accounts, still can't offset the broader slowdown of its other PayPal-branded services.

PayPal's total take rate, or the percentage of each transaction it retains as revenue, rose year over year from 1.99% to 2.03% -- but that improvement also couldn't offset its slowing growth in active accounts and transactions.

PayPal expects its revenue to rise 8.5% (10% in constant currency) for the full year, compared to its prior forecast for 10% growth and its 18% growth in 2021. That softer guidance is disappointing, but PayPal's growth could potentially stabilize in 2023 as the macro situation improves, the dollar weakens again, and it fully laps its decoupling from eBay.

3. Declining operating margins

PayPal's operating margin rose 330 basis points sequentially to 22.4% on a non-GAAP (generally accepted accounting principles) basis in the third quarter, which surpassed its own guidance by about 2 percentage points. It mainly attributed that sequential expansion to more disciplined spending as its top-line growth decelerated. 

But that still represents a 140 basis point decline from its operating margin of 23.8% a year earlier. It's also still well below its non-GAAP operating margin of 25.1% in 2020 and 24.8% in 2021. That pressure could persist as it ramps up its investments again or expands its lower-margin services (including its buy now, pay later features) to attract more users.

PayPal now expects its adjusted EPS to drop 11% to 11.5% for the full year, which is better than its prior forecast for a 14% to 16% decline but still a disappointing reversal from its 19% growth in 2021. On the bright side, Schulman expects PayPal to deliver "no less" than 15% adjusted EPS growth in 2023 as it focuses on "driving continued operational efficiency."

Is PayPal's stock a turnaround play?

PayPal's stock might look cheap at 15 times forward earnings, but investors should recall that it vastly overestimated its own long-term growth potential last year while underestimating the near-term impact of eBay's departure as well as the macroeconomic and competitive headwinds. It also repeatedly reduced its guidance over the past few quarters, so it's tough to take management's optimistic expectations for 2023 too seriously.

PayPal isn't doomed yet, but I wouldn't touch its stock until its growth in active accounts and transactions stabilizes. For now, investors should stick with more promising tech stocks instead of betting on PayPal's long-term recovery.