As a leader in the electronic payments space, PayPal's (PYPL 0.34%) fortunes were boosted by the coronavirus pandemic. With consumers spending more time than ever at home, online shopping surged, and with it, PayPal's share price jumped 256% between the March 2020 low and the peak in July 2021.
However, what goes up must come down. This fintech trailblazer has been dealing with macroeconomic weakness in recent quarters, with inflation hurting discretionary spending on its network and higher interest rates helping to drive down the share price. But with the stock now down 72% from its all-time high and 51% in the past 12 months, is PayPal a buy right now?
PayPal's attractive characteristics shine bright
Inflation is a huge headwind for PayPal because its platform leans more toward discretionary purchases, and these items can be put on hold when times get tough. This dynamic helps explain the company's slowdown in 2022.
"We're operating in an environment where we think we're going to continue to have inflationary pressures, where real wage growth is going to continue to be negative for a period of time, where discretionary spend will be under pressure," acting CFO Gabrielle Rabinovitch mentioned on the third-quarter 2022 earnings call.
Despite these challenges that have adversely impacted businesses in a range of industries in 2022, there's no denying PayPal's absolute dominance in the digital payments industry. In the third quarter of 2022, the company processed $337 billion of total payment volume on its platform, which was up 9% year over year. And PayPal counts an impressive 432 million active accounts, up 4% year over year. Those accounts transacted on average 50.1 times over the trailing-12-month period, a figure that has steadily crept up over time.
Controlling a massive two-sided network of both merchants and individual consumers allows PayPal to benefit from network effects. As more accounts are added, the platform becomes even more valuable to existing users, as there is a growing number of places to shop from and an expanding potential customer base. PayPal's ubiquity is a favorable situation that makes it difficult for rivals to compete.
What's more, because the company's business model is extremely capital-light, free cash flow soared 37% to total $1.8 billion in the most recent quarter. Being a perennial cash machine has afforded the company's leadership team the ability to return excess capital to shareholders through consistent share buybacks. Since the start of 2016 through Sept. 30 last year, $15.1 billion of PayPal stock has been repurchased, which translates to 15% of the current market cap. Another $1 billion of buybacks is expected in the fourth quarter.
PayPal's valuation is steep
Those previously mentioned positive traits are certainly enough to convince anyone of PayPal's attractiveness as an investment candidate. But when it comes to looking at stocks to potentially buy, assessing a particular company's qualitative characteristics is only half the battle. The other part of the equation deals with valuation.
As of Feb. 1, PayPal's stock traded at a price-to-earnings (P/E) ratio of 44. To be fair, this is cheaper than the stock's trailing three-, five-, and 10-year average P/E multiples. However, that current valuation is still a steep price to pay for a business that is only projected to increase its free cash flow at a 12.2% compound annual growth rate between 2022 and 2026, according to Wall Street consensus analyst estimates.
Making matters worse is management's latest decision to cut 2,000 employees, equal to 7% of its overall headcount. That is not an insignificant amount by any means, and it's an admission by the leadership team that these are very uncertain times. This might also be a clear sign that the economic backdrop, and PayPal's situation, could get a lot worse before it gets better.
Nonetheless, it's hard to argue with the company's favorable attributes. But the valuation is too expensive right now, so wait for a pullback before adding PayPal to your portfolio.
