The S&P 500 is down 10% from its all-time high, putting the index on the brink of bull market territory, and history says it will close the gap eventually. The S&P 500 has suffered dozens of drawdowns over the years, but it has never failed to recoup its losses. That makes the present a good time to consider PayPal (PYPL +1.22%) and DigitalOcean (DOCN +3.58%).
Wall Street sees substantial upside for both of these fintech growth stocks. PayPal has a median 12-month price target of $85 per share, implying a 47% upside from its current price. And DigitalOcean has a median 12-month price target of $34 per share, implying a 48% upside from its current price. Of course, price targets are by no means a guarantee of future performance, but the optimism surrounding both companies warrants further consideration.
Here's what investors should know.
NASDAQ: PYPL
Key Data Points
1. PayPal
PayPal operates a two-sided payments platform that provides financial services to merchants and consumers. By participating in both sides of the transaction, the company gains an advantage over service providers that work solely with merchants. Specifically, PayPal has a better understanding of consumer spending habits, which translates into deeper insights and better fraud protection. In fact, PayPal says it has the highest authorization rates and lowest loss rates in the industry.
The investment thesis here is simple: PayPal is the most accepted digital wallet in North America and Europe, and the company holds an impressive 41% market share in online payment processing, nearly double the 21% market share held by second-place Stripe. That positions PayPal as a long-term winner from the secular shift toward online retail, a market expected to grow at 8% annually through 2030.
Turning to financial performance, PayPal reported solid results in the second quarter. Revenue increased 7% year over year to $7.3 billion, a slight deceleration from 9% revenue growth in the prior year, but non-GAAP earnings growth accelerated to 24% as cost control efforts continued to bear fruit. Management expects similar results in the second half. Guidance calls for full-year revenue growth of 9% and full-year non-GAAP earnings growth of 20%.
PayPal plans to prioritize three investment opportunities in the years ahead: its PayPal and Venmo digital wallets, branded PayPal checkout, and unbranded Braintree checkout. That strategy should protect its leadership in online payment processing and keep its top-line growth aligned with e-commerce sales. That means investors can expect high-single-digit revenue growth in the coming years.
However, PayPal should be able to increase its bottom line more quickly through ongoing cost reduction efforts and share repurchases. Indeed, Wall Street expects long-term annual earnings growth of 16% on a per-share basis. That forecast makes its current valuation of 16.1 times earnings look very attractive. In fact, it is the cheapest earnings multiple in PayPal's history as a public company. Patient investors can buy this fintech stock with confidence.
NYSE: DOCN
Key Data Points
2. DigitalOcean
DigitalOcean simplifies cloud computing for small and medium-sized businesses (SMBs). Larger cloud providers like Amazon Web Services (AWS) and Microsoft Azure offer a broader and more sophisticated range of products, but those products are typically designed for enterprises with robust IT support.
DigitalOcean does away with that complexity. Its click-and-go functionality makes it possible for developers to spin up cloud environments in minutes, without any specialized training. DigitalOcean also provides round-the-clock customer and technical support to SMBs, something they would have trouble getting from the likes of AWS and Azure.
Focusing on SMBs differentiated DigitalOcean, potentially making the company more vulnerable to macroeconomic conditions because smaller businesses sometimes lack the resilience of larger enterprises. Indeed, DigitalOcean saw its retention rate drop to 104% in the second quarter -- its lowest level in three years -- meaning the average customer spent just 4% more. Yet revenue still increased 27% to $170 million, and cash from operations jumped 39% to $64 million.
Looking ahead, DigitalOcean has several tailwinds at its back, and chief among them are the operational benefits of cloud computing and strong demand for technologies like artificial intelligence (AI). To that end, the company values its addressable market at $98 billion in 2023, but management sees that figure reaching $195 billion by 2026.
DigitalOcean is steadily expanding its service offering to capitalize on that opportunity. It recently acquired supercomputing infrastructure provider Paperspace, a move that will allow customers to more easily build and deploy AI applications. DigitalOcean also introduced a managed version of Apache Kafka, a data streaming platform that supports real-time analytics. Customers can now use Kafka without the burden of managing the underlying infrastructure.
With that in mind, investors can conservatively count on annual revenue growth in the mid- to high-teen percentages for the next three to five years. Indeed, Morgan Stanley expects DigitalOcean to grow revenue at 16% annually through 2026. That makes its current valuation of 3.4 times sales -- the cheapest in company history -- look quite reasonable. Investors should buy a small position in this cloud growth stock today.
