The Nasdaq Composite dipped into a bear market last year, and the tech-heavy index is still 28% off its high. Losses of that magnitude can be frightening, but indiscriminate drawdowns are actually a good time to put money into the stock market.
Why? Investors often overreact to good and bad news, so stocks tend to rise too high during bull markets and fall too far during bear markets. Warren Buffett hinted at that quirk of human nature when he said, "Be fearful when others are greedy, and be greedy when others are fearful."
With that in mind, PayPal Holdings (PYPL 0.64%) and Upstart Holdings (UPST 0.79%) have seen their share prices plunge 74% and 95%, respectively, from all-time highs, but both stocks could rebound when economic conditions improve. Here's why.
PayPal Holdings: The most accepted digital wallet in North America and Europe
PayPal hit investors with two pieces of bad news early last year. Citing economic headwinds, the company cut its 2022 guidance and withdrew its medium-term financial targets, including its goal of reaching 750 million active accounts by 2025. That bad news, coupled with slowing growth, contributed heavily to the sharp decline in its share price.
Fortunately, PayPal adapted quickly to the challenging environment, and the company reported respectable results in the third quarter. Revenue climbed 11% to $6.8 billion and free cash flow soared 37% to $1.8 billion. To maintain that momentum, PayPal plans to cut $1.3 billion in operating expenses this year, which should boost its operating margin by at least 100 basis points, according to management.
More importantly, the company is set to reaccelerate growth when inflation normalizes and consumer spending rebounds. PayPal operates one of the largest payment networks in the world, with 432 million active accounts, and the two-sided nature of that network affords the company a significant advantage. Whereas most payment service providers work solely with merchants, PayPal provides financial services to merchants and consumers, allowing the company to amass data (and build trust) on both sides of the transaction.
So what? CEO Dan Schulman says PayPal's trust brand boosts conversion rates at checkout by 34% compared to other digital wallets, and because it has a deep understanding of consumer spending patterns, PayPal also has the lowest loss rates in the industry. Those selling points have made PayPal the most accepted digital wallet in North America and Europe, reflecting the value it creates for merchants. But PayPal also ranked as the second-most-downloaded digital wallet worldwide in 2022, reflecting the value it creates for consumers.
Looking ahead, shareholders should expect strong growth for many years to come. PayPal values its addressable market at $110 trillion, and that figure will only get bigger. For instance, Juniper Research says the number of digital wallet users will grow 53% between 2022 and 2026, and eMarketer estimates that global e-commerce spend will climb 43% during the same period. Both of those trends should be tailwinds for PayPal. And with shares trading at 3.4 times sales, an absolute bargain compared to the three-year average of 9.1 times sales, now seems like a good time to buy this stock.
Upstart Holdings: A disruptive force in the lending industry
Upstart is on a mission to disrupt the multitrillion-dollar lending industry with sophisticated machine learning, a type of artificial intelligence (AI) that improves over time. Its platform logs over 1,500 data points per borrower -- far more than traditional FICO-based credit models -- and it leans on AI to correlate those variables with outcomes like fraud and default. That helps banks and other lenders quantify credit risk more precisely, which ultimately leads to lower loss rates.
Unfortunately, Upstart has struggled amid the challenging economic environment. High inflation and rising interest rates created financial headwinds for consumers, causing an uptick in delinquency rates across the industry. As a result, banks and other lenders are exercising more caution when extending credit. That domino effect translated into dismal third-quarter financial results for Upstart. Revenue dropped 31% to $157 million, and the company reported a loss of $56.2 million, down from a profit of $29.1 million in the prior year.
However, investors need to contextualize those metrics. In addition to economic headwinds, Upstart is also navigating another difficult situation. Its AI models have never been tested during a down period in a credit cycle, so lenders are naturally cautious to adopt its technology. But since 2018, Upstart's AI models have separated high-risk borrowers from low-risk borrowers with five times more precision than FICO-based models. That hints at a competitive advantage.
Of course, historically low interest rates and federal stimulus checks helped suppress defaults over the last few years, creating an ideal environment for lenders. But if Upstart maintains its superiority over traditional credit models throughout the current economic environment, lenders would likely be much more willing to adopt its AI platform.
On that note, management puts its addressable market at $1.5 trillion, a figure that includes $146 billion for personal loans, $786 billion for auto loans, and $644 billion for small business loans. Upstart has yet to put a dent in that opportunity, and with shares trading at a reasonable 1.7 times sales, risk-tolerant investors should consider buying a small position in this growth stock.
