Not long ago, financial technology, or fintech, was the hottest investment thesis on Wall Street. While many trends have come and gone since then, the prevalence of digital payments has stuck around. However, the stocks have fallen out of favor with investors, and many fintechs have struggled over the past few years.
PayPal (PYPL 2.90%) is a case in point, and the stock is down nearly 80% from its all-time high and trading at levels not seen since 2017. Stats like that might lead investors to believe that PayPal has been a failure. While PayPal has had its share of blunders, it has still succeeded in growing its digital-wallet product.
So should investors consider buying PayPal stock? Read on to find out.
PayPal's revenue growth has been weak
Part of PayPal's stock problem is a bit of an identity crisis. PayPal used to be one of the hottest growth stocks available. However, with the company only increasing revenue in the high-single digit percentages over the past two years, the growth-stock title has been stripped from PayPal.
That would shift PayPal into value-investing territory, but if you took a survey from most investors, I'd say very few would consider PayPal a value stock.
So with no true home for PayPal, its stock has struggled and is down 12% this year, while the rest of the market is up 17%. But if you're a PayPal investor like me, don't lose hope. The company isn't doing as badly as the stock price would lead you to think.
In the second quarter, PayPal's revenue rose only 7%, while total payment volume rose 11% year over year. While that's not blazing-fast growth, it supports PayPal's transition into a more mature company. Management expects more of the same in Q3 as it forecast 8% revenue growth.
Digging in a bit deeper, it becomes clear that PayPal's active accounts fell 1% compared to Q1 and were little changed compared to last year's Q2. However, the number of payment transactions per active account was up 12%. This shows that while PayPal isn't adding new users, it's getting its existing ones to utilize the product more. Without the combination of account growth and use growth, PayPal's revenue growth will continue to be in the high single-digit range.
But the revenue growth isn't what is impressive with PayPal; its earnings growth is. Earnings per share (EPS) rose from a $0.29 loss last year to a $0.92 profit this year. This huge turnaround comes from reduced operating expenses across the board. In Q2 last year, PayPal's operating expenses totaled $2.55 billion compared to this year's $2.22 billion. That's a 13% decline and shows management's commitment to becoming a more efficient business.
It also is aggressively repurchasing shares, as it bought $1.5 billion in stock this quarter and plans to buy about $5 billion this year. PayPal's stock-based compensation bill was a modest $376 million in Q2, so the actual effect of the repurchase was about $1.15 billion or about 1.5% of the shares outstanding. That's a hefty repurchase plan, but PayPal is choosing to do the right thing while the stock is cheap.
But just how cheap is the stock?
The stock has never been this cheap
Because PayPal is going through a significant business transformation by becoming more efficient, it's better to look at the forward price-to-earnings (P/E) ratio rather than the trailing one. From this perspective, PayPal's stock is on a different level of cheap than we've ever seen.
Data source: YCharts.
A level of 12.7 times forward earnings is a level few stocks trade at unless they are distressed. PayPal isn't in that state, and it makes me wonder why the stock doesn't garner more respect. To me, it all boils down to growth versus value-style investing. Because PayPal doesn't have a home in either camp, it's an unloved stock.
Unloved stocks with businesses doing just fine are a great place to invest, so I think investors should scoop up some PayPal shares at a screaming bargain price. While the stock may take some time to recover, I think it will be a worthwhile investment.
