While many investors know that PayPal (PYPL 2.90%) has struggled over the past couple of years, fewer might understand the magnitude of its fall. From its peak in August 2021 to now, the company's market cap has declined from $360 billion to $90 billion. That's quite the fall, but is the sell-off overdone? One metric and its direction seem to indicate so.
Consumers are using PayPal more, but for smaller purchases
PayPal is an odd man out in the payments world. It isn't integral to a phone operating system, and thanks to eBay cutting ties with the platform, it isn't a primary payment-processing tool for any commerce stores.
Instead, it's surviving because it is a well-known player in payment processing, and many consumers trust it. Not only is it surviving, it's also seeing increased use.
In the third quarter, payment transactions per active account (defined as an account that has made at least one transaction in the past 12 months) rose to 50.1 in a rolling-12-month period. That's up 13% over last year's third quarter and marks an acceleration of growth for that metric.
Because PayPal's customer growth is relatively slow (the number of active accounts only rose 4% this quarter), it must rely more on the increased use of its services. With the average transaction at $59.72 versus last year's $63.25, some might view this as a bad sign.
However, I think it's the opposite. As average transactions per account rise and the value falls, consumers are using PayPal more for lower-priced purchases, indicating that it is becoming a part of daily spending habits. If it can continue on this path, it is a good sign for the business (although if the number falls too low, that could be a warning sign).
In Q3, PayPal's total payment volume (TPV) -- how much money PayPal processes in a given time period -- rose 9% over last year to $337 billion. This indicates that despite a lower average transaction value, the sheer number of transactions made up for the difference.
But that's not the primary reason PayPal looks like a buy to me.
PayPal's free cash flow is moving in the right direction
When analyzing any business, whether a large blue-chip company or an explosive tech stock, free cash flow (FCF) is a metric that reigns supreme. FCF is the lifeblood of any business, and it's what investors want to see because it could eventually reward them through share repurchases or dividend payments. The cash that FCF adds to the balance sheet can also be used to pay off debt or acquire other businesses.
It's also important that this metric is increasing because it shows responsible growth, as a company could spend a large chunk of change on advertising to drive a meager revenue increase. Just like any metric, FCF can be influenced by short-term financial engineering, so looking at a long-term trajectory is key for properly assessing this metric.
Despite some hiccups along the way, PayPal's FCF trajectory is strong.
PYPL free cash flow; data by YCharts.
In the third quarter, PayPal posted its highest organic quarterly FCF rise in history and an impressive 26% FCF margin. If PayPal can sustain this margin, it will show substantial FCF improvement in 2023, as its usual margin is about 20%.
PayPal is using this FCF to return capital to shareholders: $3.2 billion in 2022 (about 78% of total FCF) in the form of share buybacks. Considering PayPal has been below $100 billion in market cap throughout most of 2022, that's a decent chunk of the company being repurchased.
Buybacks do no good if companies repurchase their shares at the wrong price. However, with PayPal's dirt cheap valuation of 15.9 times FCF, I'd say it's a responsible use of capital.
This metric brings me to my reason PayPal is a screaming buy: its FCF yield. FCF yield is the inverse of price-to-FCF, showing how much FCF a company generates with respect to its market cap. A good indicator if a company is under- or overvalued is comparing this metric to the yield of a 10-year Treasury note. Considering that a 10-year Treasury currently yields 3.6%, I'd say PayPal is a bargain at a 6.29% FCF yield.
PYPL free cash flow yield; data by YCharts.
With PayPal producing 6.3% of its market cap in FCF annually, it has the ability to repurchase stock or pay down debt rapidly, two things investors would be thrilled to see.
PayPal is one of the more attractively priced stocks on the market. And with Wall Street analysts on average guiding for 9.1% revenue growth for 2023, it's not done growing revenue or FCF, either.
Despite how 2021 and 2022 went for the stock, I think 2023 will probably be an excellent rebound year for PayPal. If not, then the share repurchase program will likely ramp up, giving long-term shareholders an even bigger advantage over those who wait to purchase shares.
Is PayPal going to provide lights-out growth? Unfortunately, no. But if you can switch your mindset more to value investing, it has excellent potential.
