According to Adroit Market Research, the financial technology (fintech) market is expected to have a compound annual growth rate (CAGR) of more than 20% through 2030, reaching $700 billion compared with $100 billion now. Multiple third-party research groups similarly project high growth for fintech in coming years, which is good reason for investors to consider PayPal Holdings (PYPL -1.67%) and Block (SQ -4.53%).
Let's look at which one is the better stock for 2023 and beyond. My answer might surprise you.
1. PayPal stock has never been this cheap
PayPal is a pioneer in the fintech space. And with 432 million active accounts, it's also one of the biggest players.
Over the last four quarters, PayPal has generated nearly $5.7 billion in free cash flow (FCF), which is one way to measure profitability. Trading with a current market capitalization of $78 billion, this means it trades at just 14 times trailing FCF -- the cheapest it's been since it was spun out from eBay in 2015. But more context unlocks the truly impressive value proposition for PayPal investors today.
PYPL Price to Free Cash Flow data by YCharts
In recent years, PayPal management has focused on expanding its business into ancillary financial-technology services, with limited success. And unfortunately, this has held back FCF a bit lately, as the chart below shows. However, with a renewed focus on its core strengths, PayPal is starting to live up to its full potential for FCF generation, and I expect it to continue to improve and for its valuation to look all the more attractive.
PYPL Free Cash Flow Per Share data by YCharts
Shareholders have already been told about PayPal's game plan for 2023. In the conference call to discuss financial results for the third quarter of 2022, PayPal Chief Financial Officer Gabrielle Rabinovitch said, "Returning capital to our shareholders continues to be our single biggest priority from a capital allocation standpoint and I think it will continue to be."
So far in 2022, PayPal has spent nearly $1 billion per quarter on share repurchases and expects to maintain a comparable pace in 2023. This equates to more than 1% of shares outstanding per quarter.
PayPal isn't a high-growth opportunity like it once was -- it's only forecasting 7% year-over-year revenue growth in the current quarter. And it's only grown year-to-date revenue by 9% from the comparable period of 2021. However, with consistent share buybacks, it's possible for PayPal to increase revenue per share by a double-digit percentage, which should be enough to beat the market in 2023 and beyond.
2. Block stock is inexpensive as well, with a catch
In contrast to PayPal, Block is still a higher-growth opportunity mostly thanks to its Cash App ecosystem. With Cash App, users can invest, transfer money to other Cash App users, and more. They can also do more traditional banking things like direct deposit their paychecks and get a debit card.
The Cash App Card is important fuel on Block's fire. In the third quarter of 2022, cardholders reached 18 million and accounted for half of all cash inflows into the business. This is important. Once money is in the system, it's highly likely users will stay and use the money inside of the ecosystem.
Block's management focuses on gross profit. It's not a perfect valuation metric. But let's look at it from this perspective for the sake of argument, since this is management's emphasis.
Block has $5.5 billion in trailing-12-month gross profit and has a market cap of $36.2 billion. This valuation of a little less than 7 times its gross profit is historically a cheap valuation for this company. And its gross profit is still growing fast, up roughly 34% through the first three quarters of 2022 compared to the comparable period of 2021. Steady growth in the Cash App ecosystem is fueling these gains.
As mentioned, Block is higher-growth than PayPal and I believe Cash App has plenty more room from here. Moreover, from certain perspectives Block looks like a cheap stock. However, Block does have more uncertainty than PayPal -- in 2023, it will keep funneling money into projects like music platform Tidal and cryptocurrency, which both have uncertain payoffs.
Here's another problem: After acquiring buy now, pay later company Afterpay, Block has an astounding $11.6 billion of goodwill on its balance sheet. Considering Block acquired Afterpay at a time when valuations were running hot, it's very likely it will need to write off some of this goodwill in 2023, resulting in a big hit to profitability. It'll be a noncash charge, but the market is sure not to like it.
For everything discussed here, I would say that PayPal stock and Block stock are both great opportunities for 2023 and beyond, but for different sets of investors. If you're an investor who wants respectable upside with limited downside risk, I'd suggest buying PayPal. However, if you're willing to take on more uncertainty for a stock with more upside potential, Block might be the stock for you.
You may not have expected an answer like this. But this is often true of investing: The better investing opportunity sometimes comes down to your personal situation, as is the case with PayPal and Block, in my opinion.
