Shares of PayPal Holdings (PYPL 0.47%) were trading lower following its first-quarter earnings report on Monday.  Revenue came in ahead of management's guidance. PayPal also raised its full-year outlook for earnings per share, which should have helped lift a stock that continues to trade at a discounted valuation to the market average.  

Still, the market's lack of enthusiasm could be a great buying opportunity for patient investors. Let's look at the key highlights from the quarter and what they mean for PayPal.

Financial highlights

Here's how PayPal fared on key performance metrics in the first quarter:

  • Revenue increased by 10% year over year on a currency-neutral basis to reach $7.04 billion. This was driven by a 12% increase in total payment volume.
  • Active accounts grew 1% over the year-ago quarter to reach 433 million but dropped 2 million over the fourth quarter. Management credited the sequential decline to higher churn from minimally engaged accounts and the decision to focus on driving higher transaction activity with existing customers.  
  • Transaction expense is the largest expense bucket, which increased 16% year over year. But PayPal continues to get leverage out of its non-transaction expenses like customer support that are driving earnings growth.
  • A 12% decline in non-transaction expense helped drive non-GAAP (adjusted) earnings per share up 33% year over year to $1.17.
An infographic showing PayPal's first-quarter financial results.

Wall Street has been worried about PayPal losing market share in branded checkout to competing digital wallets. However, branded checkout grew 6.5% year over year, an acceleration of two percentage points over the previous quarter.

Meanwhile, unbranded credit card processing from third parties also accelerated in the quarter, up 30% year over year. But the downside with unbranded processing is that it generates a lower profit margin. 

It's these concerns about PayPal's competitive position and the lower margins from unbranded checkout growth that explain why the stock is down after the earnings report. The market is still trying to get a read on the competitive position of PayPal's platform relative to the increasing adoption of Apple Pay and other competitors that are ramping up their offerings. The flattish growth in active accounts will only strengthen the bears' case.

PayPal's profitable growth is undervalued

The market might be nitpicking PayPal's results too much. To PayPal's credit, management is getting more out of its existing customers, as transactions per account increased 13% year over year. 

Management is also doing an excellent job of keeping a tight lid on non-transaction costs, including leveraging the fixed costs in customer support, general and administrative, and technology to allow more revenue growth to fall straight to the bottom line. That has resulted in accelerating adjusted earnings growth over the last two quarters.

After reporting a decline in adjusted earnings of 2% in the third quarter last year, PayPal posted an 11% increase in the fourth quarter and 33% in the first quarter. With management raising full-year earnings guidance on top of that strong performance, the stock looks like a steal trading at a price-to-earnings ratio of 15 based on this year's guidance.