Shares of PayPal (PYPL -1.83%) have fallen out of favor with investors, down 79% from their all-time high as of this writing. The business was booming during the worst days of the coronavirus pandemic, but with consumer behavior normalizing and economies reopening, PayPal is seeing growth slow dramatically.
Is it time for investors to ditch the stock? Or is this top fintech company worthy of a place in your portfolio? Let's take a closer look.
Reasons to sell PayPal
What's strikingly clear is that the monster growth we saw PayPal post in 2020 and 2021 might never be achieved again. The business increased revenue 8.5% in 2022, while adding just 8.6 million net new active accounts, a far cry from the previous two years. And in the first three months of this year, PayPal's user base shrank slightly from December of last year. Does that mean the platform has reached its full potential?
That might be the case. While online shopping was booming when everyone was stuck at home, things are returning back to normal. Top e-commerce companies, including Etsy and even Amazon, have reported sales slowdowns in recent quarters, a sign that consumers could be favoring in-person retailing once again. Because PayPal is the most widely accepted digital wallet in North America and Europe, this trend hurts the business.
Moreover, inflationary pressures are a serious headwind for PayPal. Consumers are stretching their budgets and paying more for the essentials, which results in lower amounts of discretionary spending power.
And although the payments industry produces some of the best businesses in the world -- think Visa and Mastercard -- the competition for a company like PayPal is stiff. When it comes to online checkout, which is PayPal's core feature, Apple Pay is starting to make inroads. Its usage soared during the key holiday shopping season. This is also a threat when it comes to in-person transactions.
And with Venmo, the PayPal-owned popular peer-to-peer service that counts 60 million monthly active users, the company has to compete with Zelle, operated by a consortium of big banking institutions, as well as with Block's Cash App.
Reasons to buy PayPal
Because the stock has been crushed over the past few years, it trades at a price-to-earnings (P/E) multiple of 27 right now. That's well below the trailing five-year average P/E ratio of 55. That tells me investors have gone from being extremely optimistic about this business to striking a pessimistic tone. With Wall Street consensus analyst estimates forecasting annualized net income growth of 28% between 2022 and 2027, the potential for good returns is in the cards, especially keeping the valuation in mind.
The business is doing a great job at getting more engagement from its user base. In the latest quarter, transactions per active account were up 13%. This remains a key strategic focus for CEO Dan Schulman.
PayPal's two-sided platform, consisting of 35 million merchants and 398 million individuals, has allowed the company to benefit from network effects, probably the strongest economic moat there is. That just means that as PayPal brings on more merchants, consumers find more value in using the service. The opposite, where more individuals increase the usefulness for merchants, is also true. It gives PayPal a powerful competitive position that's almost impossible for a smaller rival to catch up to.
Network effects can also help to explain why the business is so lucrative. In 2022, PayPal generated $5.1 billion of free cash flow on $27.5 billion of revenue, a superb margin of 19%. The balance sheet is in pristine condition, with a net cash position of $4.4 billion. And with the leadership team finding ways to cut substantial costs across the board, the company is set to become even more efficient in the future.
While PayPal's growth has slowed considerably, and it faces intense competition, I think the attractive valuation being offered for what is still a competitively advantaged business makes the stock worthy of being a buy today.
