As the undisputed leader in digital payments, with acceptance at 79% of the top 1,500 retailers in North America and Europe, PayPal (PYPL 1.43%) saw its business grow like wildfire during the pandemic. Payment volume, active accounts, and revenue surged in 2020 and 2021.
But it's been a different story lately. With growth slowing, the stock is down 76% from its July 2021 high -- and one legendary investor has completely exited his fund's position in the fintech leader as of the end of 2022. Should you do the same? Let's take a closer look.
The best investor you probably never heard of
Terry Smith, who many call Britain's Warren Buffett, adopts a similar investment philosophy as the Oracle of Omaha. This means exclusively focusing on the best businesses out there that possess competitive advantages and can compound capital at high rates over long periods of time.
As of Dec. 31, Smith's firm, aptly called Fundsmith, held well-known tickers like Microsoft, Philip Morris, and Estee Lauder as some of its largest positions. Since inception in November 2010, the fund has produced an annualized return of 15.6% after fees (as of Feb. 28), handily beating the MSCI World Index's 11.2% yearly return during the same time.
Fundsmith has owned PayPal ever since it was spun off from eBay in 2015. And it looked like a successful investment for a long time. Revenue soared from $9.2 billion in 2015 to $27.5 billion last year. And at their peak, the shares were up a whopping 740%. But rising competition, higher expenses, and slowing growth amid macro weakness have since crushed the stock.
Smith continues to own Visa, so he is familiar with the payments industry. However, Smith's fund completely exited its PayPal position in the last three months of 2022. The stock has produced a 105% lifetime return (as of March 22), higher than the 92% gain for the S&P 500 during the same time.
PayPal's red flags
Known to be extremely straightforward in his reasoning for why he likes or dislikes a company, Smith says his problems with PayPal were ones that even individual investors could have recognized early on.
To be specific, he called out the fact that the business wasn't doing much to engage more with new customers that were acquired during the pandemic. He also cited a lack of adequate cost controls. And he believed that PayPal severely overpaid for acquisitions. The $4 billion purchase of Honey and the $2.7 billion purchase of buy now, pay later company Paidy come to mind.
"PayPal seems intent on snatching defeat from the jaws of victory," Smith wrote in his fund's 2022 investor letter. Perhaps the announced retirement of current CEO Dan Schulman might be welcome news.
It's worth noting that Smith and his firm even tried to engage with PayPal's management team on trying to address these issues, but the effort bore no fruit. This is surprising, given that Fundsmith's assets under management of £22.8 billion make it a sizable investor. Elliott Management, a well-known activist investor, held the stock for a substantially shorter period of time than Fundsmith, but was awarded a board seat. This didn't sit right with Smith and his team.
With this information, it's ultimately up to existing shareholders to decide what to do with their PayPal positions. While it's never a good idea to blindly follow any investor's actions, no matter how impressive that investor's track record, the fact that Terry Smith entirely sold off the stock is telling. On the other hand, for investors who still believe that PayPal has a bright future ahead, despite the world-class investor's move, it could still be worthwhile to hold on to your shares.