One of the most notable stock swings in recent years has been PayPal's (PYPL 0.39%). The company's business was thriving throughout the social-distancing phases of the pandemic, and its stock was likely one of the best performers in many investors' portfolios. However, since then, slowing growth, macroeconomic headwinds, and the market's disdain for expensively valued stocks have taken a toll on its price. PayPal's shares currently trade about 83% below their peak.
To be clear, PayPal is a beaten-down stock, and the fact that its price has been in decline for more than two years now might scare away some investors. But a compelling argument can be made that its shares could double over the next five years. Here's what it would take for that to happen to this fintech enterprise.
Returning to growth
In Q2, its most recently reported quarter, PayPal's revenue was up just 7% year over year, a far cry from the consistent double-digit percentage top-line growth it registered in the years before 2022. Total payment volume increased by 11% to $377 billion. And PayPal's base of active accounts appears to be leveling off -- for the quarter, it was 431 million. That was up 2 million year over year, but down 2 million sequentially. These are troubling signs for a business that long held the attention of growth investors.
A tougher macroeconomic environment is kryptonite for companies like PayPal that rely on consumer discretionary spending. Plus, PayPal now must deal with unflattering financial comparisons to its past.
However, there are reasons to be optimistic about its outlook for the next five years.
For starters, PayPal is in a league of its own when it comes to acceptance of its digital wallet. Among the largest U.S. retailers, its products have nearly three times more adoption than the No. 2 competing digital wallet. Of course, having more than two decades of experience in electronic payments has made PayPal a trusted name when it comes to e-commerce and point-of-sale transactions.
The company is also solidly profitable, with healthy margins and strong cash generation. That combination of attributes puts PayPal in a different category than most of the other fintech companies out there.
NASDAQ: PYPL
Key Data Points
Investors will also appreciate PayPal's network effects. A two-sided platform like the one it operates becomes more valuable for its users the larger it gets. The large number of merchants accepting its payment systems creates lots of shopping opportunities for existing account holders and provides an incentive for new people to sign up. And having more consumers on the platform means merchants have a growing customer base that they are able to sell to, and those merchants that haven't signed on yet have more reasons to do so.
The fact that the secular trend toward a greater use of cashless transactions can still make lots of headway on a global level means that PayPal has a powerful tailwind at its back.
Indeed, analysts on Wall Street have extremely positive outlooks for PayPal. Between 2022 and 2027, their average forecast is that this digital payments leader can increase its revenue and diluted earnings per share at compound annual rates of 10.4% and 26.3%, respectively. Those would be outstanding results. If the company delivers results similar to those expectations, its stock would likely be a big winner.
Valuation upside
It's accurate to say that PayPal's stock is down and out. But the benefit is that it's extremely cheap relative to its historic valuations. As of this writing, the stock trades at a trailing price-to-earnings ratio of about 15.1 -- near its all-time low. That depressed multiple makes the company's earnings ratio of 109.4 at its peak in June 2020 look absolutely outrageous.
Investors should want to buy stocks when they are trading at cheaper valuations because such discounts offer greater possibilities for upside while also introducing a margin of safety. Sometimes, the best time to buy shares in a business is when no one else wants to.
Looking out five years from now, it's anyone's guess what PayPal's price-to-earnings multiple will be. But I think it deserves to be higher than where it is currently.
The S&P 500 and the Nasdaq 100 indexes trade at trailing price-to-earnings ratios of 18.8 and 30, respectively. If in five years, PayPal's shares are valued at around the average of those two ratios -- let's say 25 -- that would potentially add a 67% tailwind to the stock's returns. And that doesn't even include the possibility of the company's improving its fundamental performance.
Could PayPal stock double in five years? Yes, it's certainly on the table. All the necessary ingredients are there for it to happen.
