These are scary times, no doubt. A potentially looming recession, elevated inflation, a recent string of bank failures, and rising interest rates aren't exactly developments that investors cheer. Those who focus on growth stocks like PayPal (PYPL 1.44%) have even more to think about in today's market environment. It's worth asking if it's still a good idea to own a business like this.
PayPal's stock is down 36% over the last 12 months, seriously underperforming the S&P 500, which has fallen 11% during the same period. Where will shares of the fintech be in one year? I think it's important to understand where the company has been, and what its outlook is, to answer that question.
Posting modest gains
Last year was still a healthy one for PayPal, with an 8% increase in sales to $27.5 billion. Total payment volume of $1.36 trillion was up 9% versus 2021. And the business added 8.6 million net new active accounts, bringing the total to 435 million. All things considered, this is respectable growth, albeit not at the rates shareholders saw in 2020 and 2021.
What stands out about PayPal is its ability to produce cash. The company generated $5.1 billion of free cash flow (FCF) in 2022, up 4% year over year. This is something that shareholders can appreciate right now, given the uncertainty rattling markets and the economy. The ability to produce copious amounts of FCF, coupled with PayPal's net cash position of $5.1 billion (as of Dec. 31), can allow the company to continue to invest in worthwhile growth opportunities when rivals might be a bit more conservative with their capital expenditures.
"While the macroeconomic backdrop remains challenging, we're energized by the significant opportunity we have to advance our leadership in payments and better serve our customers," Chief Financial Officer Gabrielle Rabinovitch said on the Q4 2022 earnings call.
For a business that relies on rising spending for its success, the current environment isn't exactly ideal. But the management team expects revenue to increase 9% in the current quarter, with Q1 2023 adjusted earnings per share (EPS) rising between 23% and 25% year over year. Wall Street analysts on average expect PayPal sales to jump 6.7% in 2023. These are still solid gains.
A year marked with uncertainty
With the stock down 77% from its peak in July 2021, PayPal currently sells at a trailing price-to-earnings (P/E) ratio of 34. The stock's average historical P/E multiple is 51, so the valuation today looks compelling. However, PayPal is trading at a premium to the rest of the market. And this situation could present some downside risk should the business miss quarterly analyst expectations or if the market decides to favor safer stocks even more than it already does.
Although I think it's impossible to predict what will happen with a stock in a 12-month period, it's clear that PayPal -- and every other business, for that matter -- is navigating a difficult economic environment right now. To be more specific, with inflation still running hot (the consumer price index was up 6% in February on an annualized basis, well above the Federal Reserve's 2% target), consumer spending is coming under mounting pressure. Because PayPal rises and falls with discretionary purchases, any deterioration in spending means that the business and the stock could be challenged in 2023.
It's certainly important to understand what's going on right now for investors to have context. But luckily, the fact of the matter is that investing is a long-term game; you should be looking out over the next three to five years when analyzing whether PayPal makes for a good buy today.
In this light, the company might look like an attractive opportunity. Wall Street analysts think that PayPal's revenue and EPS will increase at compound annual rates of 8.3% and 24.2%, respectively, between 2022 and 2026. If these projections pan out, then that would definitely help drive shares higher over time.
To be clear, however, despite its huge lead in the world of digital payments, the business does have powerful competition, most notably from the burgeoning Apple Pay, as well as from Block, which competes more directly with PayPal to attract merchants and individual consumers.
It's up to investors to decide if PayPal's pros outweigh the cons. One thing I am sure about is that the company's next few years will be more difficult than that last few, especially 2023.