Fintech specialist PayPal (PYPL 2.90%) has been a disappointing investment in 2023. The company's share prices are down 19% so far this year over concerns about slowing growth, a major leadership change, and other issues. It might be tempting for some PayPal investors to cut their losses at this point and dump their stock, but that could be a mistake.
Despite recent struggles, there are reasons to believe PayPal can reverse course next year. And more importantly, it remains an excellent stock for long-term investors. Let's consider why.
PayPal's two-sided network
PayPal's growth slowed once the worst of the pandemic subsided and the need for its services eased. Compared to the incredible highs it hit in the early days of the outbreak -- which included some of the company's best quarters ever -- it isn't performing particularly well right now. However, it's not clear that the fintech leader is on balance worse off due to the disruptions caused by the coronavirus outbreak.
As PayPal management reported at the beginning of the year, some of the company's key metrics registered excellent compound annual growth rates (CAGR) between 2017 and 2022. To take just one example, PayPal's revenue clocked in a CAGR of 16% through this period. PayPal's top-line growth fell below that average this year but is still growing. In the third quarter, the company's revenue increased by 8% year over year to $7.4 billion.
PayPal's results partly depend on people's spending habits and patterns. The company's consumer-facing business includes various services, from its peer-to-peer payment app Venmo to fast online checkout on thousands of retailers' websites. PayPal also offers multiple services to businesses, including a payment gateway platform through its subsidiary Braintree.
PayPal's top-line growth is likely to improve right along with the economy, higher business activity for companies, and increased consumer spending. While parts of the economy weren't great this year, things haven't been that bad, especially when you consider that a recession was expected when 2023 started. In the third quarter, U.S. gross domestic product grew by about 5% -- a level of growth not seen since the fourth quarter of 2021.
This doesn't mean the economy won't tank in 2024, but at the very least, it is a decent sign of progress.
A strong economic moat
Something else going PayPal's way is the company's strong competitive advantage. First, it has developed a solid brand name that customers and businesses trust. That matters in every industry, but especially in the financial sector. When businesses offer PayPal as a checkout option, customers tend to view that business as trustworthy. That helps provide peace of mind to everyone involved in the transaction.
Second, PayPal benefits from a strong network effect. The more individuals use PayPal as a digital wallet, the more its ecosystem becomes attractive to businesses. That ensures that the company will continue adding individuals and businesses to its network over the long run, especially since it provides a comprehensive suite of services. PayPal recently expanded into buy now, pay later (BNPL) services, among other similar areas.
As of the end of 2022, PayPal's acceptance rate among the 2,500 largest retailers in North America and Europe was 79%, up from 76% the year prior. No company was even close to this: The distant second had an acceptance rate of 28%. What's more, PayPal's year-over-year three-percentage-point growth rate in the acceptance category was also larger than the other prominent digital wallets -- an impressive achievement considering its already high acceptance rate.
PayPal's economic moat will continue to matter as digital wallets rise in popularity and the fintech industry continues to expand.
The valuation looks attractive
PayPal's stock sell-off over the past 18 months has left the stock looking reasonably valued.
PYPL PE Ratio (Forward) data by YCharts
For context, the average forward price-to-earnings ratio in the financial industry is 13.8, while PayPal's forward price-to-sales ratio of about 2 and under is generally considered undervalued. Given PayPal's valuation, the fact that the business isn't performing as bad as it seems, its economic moat, and the prospects of the larger fintech industry, the stock is a solid buy ahead of 2024, at least in my view.
That's especially true for investors planning to hold the stock for five years or more. Eventually, patience will be rewarded with this top company.
