In 2020 and 2021, many investors were willing to pay egregious multiples for the shares of fast-growing companies. This has changed, however, and the tech stocks that soared have now plummeted. For example, Snowflake (SNOW 3.69%), a cloud-based data service, has seen its valuation fall from more than 150 times sales in late 2020 to about 30 today.
As a result of the shift in investor sentiment away from growth, Adyen (ADYE.Y -1.57%) stock has seen its share price tumble. Shares of the Holland-based payments processing platform are down 56% from their all-time high set in late 2021. However, some investors claim that this payment-processing company's valuation is still too lofty. While Adyen doesn't look cheap, here's why the company's valuation isn't as concerning as first meets the eye.
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Adyen looks expensive...
On an absolute basis, it makes sense why many investors believe Adyen is overvalued. The Dutch payment processing company has seen tremendous adoption, but its price-to-earnings (P/E) multiple currently sits at 85.
When compared to the broader market, Adyen's current price seems expensive. The S&P 500 index currently has a P/E of 20.6, and its average dating back to the 1870s has been 16. Therefore, a valuation like Adyen's can seem outlandish.
But there's a reason for this high sticker price
However, there's more to the company than its valuation. Excellent companies often deserve higher-than-average valuations. Just look at Costco Wholesale (COST 1.01%), for example. Over the past decade, this robust business has traded at an average of 32 times earnings -- far exceeding the market average. Today it trades at nearly 40 times earnings.
Costco gets a premium because it's a first-rate business. The same goes for Adyen. This company is firing on all cylinders, and continues to see rapid adoption, even while the macroeconomic picture has worsened. In the first half of 2022, this payment processor saw revenue soar 37% year over year to 609 million euros ($628 million), while processing volume jumped 60% as it gained market share. That's because Adyen has continued to land large customers and expand existing relationships. Over the past few months, Adyen has announced partnerships with Etsy (ETSY 0.34%) and Instacart, all while McDonald's (MCD -0.91%) has increased its reliance on the company.
What makes Adyen so unique is its profitability. Most smaller companies expanding at the rate Adyen is aren't profitable, or are breaking even, but Adyen has maintained incredible profits. In the first half of 2022, Adyen achieved a net income margin of 46%, and a free cash flow margin of 51%.
This balance of profitability and expansion is unrivaled by other payment processors. PayPal (PYPL 2.90%), for example, saw revenue increase only 8% year over year in the first half of 2022, and its net income margin sat at just 1.3%.
Look at Adyen's relative valuation
If Adyen were an unprofitable company struggling to gain a foothold in this competitive market, its valuation would certainly be too high. That's not the case here, however, so it makes sense that shares are trading at a relative premium.
Adyen is more richly priced than PayPal, which trades at roughly 45 times earnings. However, for this 80% premium, investors can get a company that has a much higher profit margin and is increasing revenue at nearly five times the rate of PayPal. Given Adyen's excellent operations and incredible ability to generate earnings, this stock doesn't look terribly overvalued.
Yes, its valuation is high on an absolute basis, but what you're getting is a great business trading relatively fairly compared to rivals. Therefore, Adyen might not be as expensive as investors think. I plan to continue adding shares to my portfolio, and you might want to do the same now that the company is down so much from its all-time high.
