After a brutal bear market, the Nasdaq Composite Index quietly entered a new bull market at the end of last month, rallying 20% from its bottom. While the index has started to recover, numerous top Nasdaq stocks remain mired in a bear market. Because of that, many still look like compelling investment opportunities, including PayPal (PYPL 2.07%).
While shares of the financial technology company have rallied about 11% from their bottom, they could have a long way to run since they're still down by a third from their peak. That slump has it trading at a bargain-basement valuation. With the company buying back its shares hand over fist, PayPal stock looks like a screaming buy right now as the Nasdaq appears to be in the early stages of a bull-market run.
Trading at a bargain price
PayPal faced its share of headwinds last year. That's evident in its earnings decline. Non-GAAP earnings slumped 10% to $4.13 per share in 2022. PayPal's bloated cost structure and the absence of a benefit from credit-loss reserves negatively impacted earnings.
However, the company expects 2023 to be a bounce-back year for earnings despite continued macroeconomic and tax headwinds. PayPal estimates its non-GAAP earnings will surge by 18% to $4.87 per share. Driving that rebound is the impact of additional cost savings, higher interest income, and shifting compensation incentives. It aligns with the company's recent trend as non-GAAP earnings have expanded at a 17% compound annual rate over the last five years.
With shares of PayPal trading at less than $75 per share, it sells for about 15.4 times its forward earnings. That's a relative bargain these days. The S&P 500 trades at an 18.1 times forward price-to-earnings (P/E) ratio, while the Nasdaq Composite trades at about 25.7 times its forward P/E. It's also worth noting that PayPal is cheaper than the Nasdaq Composite if we take its lower estimated generally accepted accounting principles (GAAP) earnings of $3.27 per share, which is less than non-GAAP earnings due to restructuring charges as the company reduces its workforce to cut costs. The fintech stock trades at 22.9 times forward GAAP earnings.
Taking advantage of the situation
PayPal has been using its free cash flow to gobble up its cheap shares over the past year. The company spent $4.2 billion on share repurchases last year. It returned 82% of its free cash flow to investors and spent $1 billion in the fourth quarter to repurchase about 12 million shares at an average price of $85.69. That helped drive a meaningful decline in outstanding shares:
PYPL Average Diluted Shares Outstanding (Quarterly) data by YCharts.
PayPal estimates it will produce another $5 billion of free cash flow this year. It plans to use about three-quarters of that money on share repurchases, or roughly $3.75 billion. With its share price even lower, its market cap is currently around $84 billion. At that bargain valuation, PayPal could retire another 4.4% of its outstanding shares this year.
That would continue the steady decline in the company's outstanding shares following its separation from eBay (NASDAQ: EBAY) in 2015. Since then, it has generated $29 billion in free cash flow, which it used to make $13 billion of acquisitions and investments, and repurchase $16 billion of its shares. Those repurchases have more than offset the dilution from stock-based compensation and acquisitions, as its outstanding shares are down 7.5% since the split from eBay.
A great value proposition
Shares of PayPal haven't yet latched on to the bull-market rally in the Nasdaq. Because of that, its stock still trades at a dirt-cheap valuation, enabling the company to gobble up even more shares. That value-enhancing buyback combined with a rebound in its earnings should eventually boost the stock price. This looming upside catalyst makes PayPal stock look like a screaming bargain these days.
