Runaway inflation and rising interest rates threaten to blunt corporate revenue growth and profitability, so many investors have responded by exiting the stock market. As a result, the S&P 500 and the Nasdaq Composite have fallen sharply this year, tumbling into bear market territory.
It may seem counterintuitive, but economic uncertainty has actually created a buying opportunity for patient investors. Many stocks brimming with potential have seen their valuations implode because of near-term concerns. For instance, shares of PayPal Holdings (PYPL 0.64%) and Cloudflare (NET -0.23%) have fallen 76% and 77%, respectively. But both stocks are well positioned to rebound during the next bull market, and a bull market has inevitably followed every bear market in the past.
Here's what investors should know.
1. PayPal: New partnerships with Apple and Amazon
PayPal is the most accepted digital wallet in North America and Europe, and it ranked as the most downloaded digital wallet globally through the first half of 2022. That success stems in large part from its two-sided network. Unlike traditional payment processors, PayPal offers financial services to both merchants and consumers, meaning it has built trust on both sides of the transaction, supercharging the flywheel effect that powers its business.
Thanks to that advantage, PayPal understands consumer spending habits better than most payment processors, and it uses that data to prevent fraud, mitigate risk, and drive sales for merchants. In fact, CEO Dan Schulman recently told investors, "People are two times more likely to shop when a PayPal button is present. With huge network effects, we are something like eight times larger than the next wallet button out in the market."
Despite a challenging macroeconomic environment, PayPal reported reasonably strong third-quarter results. Revenue climbed 11% to $6.8 billion and its generally accepted accounting principles (GAAP) operating margin improved to 16.3%, its highest level in the last four quarters. On the bottom line, GAAP earnings soared 26% to $1.15 per diluted share.
Looking ahead, shareholders have reason to believe PayPal can reaccelerate growth as economic conditions improve. The company estimates its addressable market at $110 trillion, and recent partnerships with Apple and Amazon could help it gain market share in the coming years.
In 2023, U.S. consumers will be able to add PayPal- and Venmo-branded cards to their Apple Wallets and use them anywhere Apple Pay is accepted. That could help PayPal gain share in physical retail, as Apple Pay is the most popular in-store mobile payment platform by a wide margin. Likewise, U.S. consumers can now pay with Venmo on Amazon. That could help PayPal gain share in digital retail, as Amazon is easily the largest e-commerce company in the U.S.
Those catalysts should drive share price appreciation when the next bull market rolls around. In the meantime, shares currently trade at 3.2 times sales, a very reasonable price compared to the three-year average of 9.2 times sales. Investors should jump on that buying opportunity before it passes.
2. Cloudflare: Fivefold revenue growth in the next five years
Cloudflare makes the internet faster and safer. Its global cloud platform improves the performance and security of corporate software and infrastructure while freeing customers from the costly burden of maintaining their own network hardware. Cloudflare also provides developer tools that help businesses build and deploy applications, websites, and video streaming experiences, and it recently added data storage solutions to its portfolio to augment its developer platform.
Cloudflare benefits from immense scale. Its network shares a direct connection with every major enterprise, public cloud, and internet service provider, allowing it to deliver content to 95% of internet users worldwide within 50 milliseconds. That makes Cloudflare the fastest network in the world, and that advantage has fueled tremendous demand. In fact, Cloudflare is the market leader in content delivery network software and edge development platforms.
Not surprisingly, the company is growing at a rapid clip. Its customer count climbed 18% to 156,000 over the past year, and the average customer spent 24% more, evidencing the stickiness of its platform. As a result, third-quarter revenue soared 47% to $254 million, and the company reported positive cash from operations of $43 million, up from a loss of $7 million in the same period last year.
Turning to the future, Cloudflare has only scratched the surface of its $115 billion market opportunity, and the company is well positioned to create value for patient shareholders. Cloudflare achieved an annual revenue run rate of $1 billion in the third quarter, and management says that figure will grow fivefold to $5 billion by 2027. That implies annualized revenue growth of 38% over the next five years. That type of growth should lead to a big rebound during the next bull market.
In the meantime, shares currently trade at 18.4 times sales, a bargain compared to the three-year average of 41.7 times sales. That's why investors should buy this growth stock.
