PayPal Holdings (PYPL 0.64%) was one of the biggest beneficiaries of rising e-payment use during the pandemic, due to its status as the oldest and most prominent company in the industry. The stock soared throughout 2020 into 2021 on the back of surging growth in total payment volume (TPV) and revenue. As a result, between the end of 2019 to July 23, 2021, the stock skyrocketed 185% to an all-time closing high of $308.53.
Unfortunately, rapidly rising interest rates hurt the company's results in 2022. The stock has dropped like a rock and is sitting near a 52-week low today -- demoralizing investors. Many are wondering whether they should continue holding the shares, considering the significant losses.
But the savvy long-term investor has put PayPal on their 2023 buy list. Here's why.
The company has the resources to survive a severe downturn
Although new investors have been shocked by the steep decline in its stock price, the company is in little danger of failure. On the contrary, at the end of the third quarter of 2022, PayPal had $16.1 billion in cash and investments.
While it has $10.7 billion in long-term debt, its debt-to-EBITDA (earnings before interest, taxes, depreciation, and amortization) ratio is 1.34, a strong indicator that PayPal can pay its obligations. In addition, it increased its free cash flow (FCF) by 37% year over year in the third quarter to $1.8 billion -- a sign of a healthy company capable of rewarding investors. By the end of the third quarter, it increased shareholder value by buying back $3.2 billion in stock, representing 78% of the FCF generated.
Management is addressing today's challenging economy by instituting cost cuts and productivity initiatives in an effort to achieve margin expansion and earnings-per-share growth in 2023 and beyond. You can see the progress in cost-cutting in the latest results. For example, the company successfully reduced non-transaction-related expense growth from 17% year over year in 2021 to 4% in the third quarter of 2022.
In addition to increasing its earning power, PayPal continues to generate double-digit revenue growth. Third-quarter 2022 revenue grew 11%, or 12% without the impact of foreign-currency exchanges.
Its grabbing share in e-commerce
One of PayPal's most significant growth drivers is making the checkout-process easier and more effective for online merchants. Its solution has become the first choice among online merchants for a good reason.
According to a Comscore analysis, PayPal Checkout results in more sales when offered as a checkout option, versus websites that fail to include the solution. As a result, merchants use PayPal checkout because of its effectiveness, and consumers look for the PayPal checkout button because they trust the brand.
For several years, management has claimed that it's growing faster than the overall e-commerce market, and this trend continued in the third quarter of 2022. PayPal's results show it grabbed market share in the U.S. and outpaced overall e-commerce growth.
Its branded checkout volumes shot up 4% over the previous-year's comparable period, double the 2% U.S. e-commerce growth that data from Bank of America shows. And the best part is that management expects the company to grow at or above the rate of e-commerce growth by making several improvements to the service, especially in mobile shopping.
The platform has a competitive advantage
PayPal's payment platform serves merchants and consumers, and it enjoys a two-sided network effect similar to a credit card network like Mastercard. Therefore, the value a consumer derives from using the payment service comes from the number of merchants utilizing the platform on the other side of the transaction, and vice versa.
Image source: PayPal.
One example of this network effect is PayPal's dominance in online checkout. It has 35 million active merchant accounts and nearly 400 million active consumer accounts.
Competitors can only provide an equivalent value by having a similar number of consumers and merchants using their online checkout products. This is a roadblock for many to compete effectively.
Short-term headwinds, but favorable long-term tailwinds
Investors should remain aware that the economy could significantly worsen. Some economic experts expect a recession in 2023, and PayPal is at risk of dropping further. However, over the next five to 10 years, this stock will be driven by long-term growth in e-payments, especially in e-commerce and mobile.
The market values the company at a forward price-to-earnings ratio (P/E) ratio of 14.4, below the S&P 500 forward P/E of 19.1. Since analysts project PayPal to grow faster than the S&P 500 in 2023, many consider the stock undervalued.
PayPal is a solid, profitable growth stock with little risk of failure and plenty of long-term growth ahead, as e-commerce and mobile payments rebound in the long term.
