PayPal (PYPL 2.90%) stock is down in the dumps, with a 16% decline this year versus a comparable 19% gain for the S&P 500. That might scare off some investors, while other investors might determine that it's a potentially great opportunity to buy on the dip.
If you're in the latter camp, you may be getting a great deal. At the current price, PayPal stock trades at a forward price-to-earnings ratio of less than 11. But before you decide if that's a bargain, there are three things you need to know about this company and its stock.
1. PayPal's high-growth stage is over, but it can still deliver strong gains
PayPal's revenue growth decelerated over the past two years or so. There are several reasons for this. One is simply the massive growth it enjoyed early in the pandemic, which was challenging to build on. Add to that a slowdown in e-commerce as people returned to physical store shopping, and an abundance of new fintech companies cropping up as digital shopping has become mainstream.
But even at these rates, PayPal is growing, and it's investing in its platform to remain relevant and generate engagement and sales. PayPal stock is down, but PayPal as a business has plenty of growth drivers (I'll get to that in a second) and is focusing on profitability. That could lead to a higher stock price.
Let's try a little exercise to see how this could work. PayPal stock trades at a price-to-earnings ratio of 18. For the price to double at the same ratio, earnings per share (EPS) would need to double as well. It's almost doubled over the past five years, and it's reasonable to envision it doing that again. But will the valuation stay the same? Its three-year price-to-earnings average is 52, but it's unlikely to go back there anytime soon.
We can try 25 as a reasonable valuation when the situation improves. At that valuation, for the stock to double from where it is today, trailing 12-month EPS would need to be $4.80. Management is guiding for 2023 EPS of $3.75, so that would be a 28% increase. You can see how PayPal stock can jump very quickly depending on its financial performance.
To further this argument, take a look at this chart. It demonstrates that until recently, PayPal's stock price moved in tandem with its EPS. They diverged only this year, as EPS has increased, but PayPal's stock hasn't. This is what you'd call an undervalued stock, where you would expect the stock price to rise to meet the real value.
2. E-commerce is heating up again, and PayPal will benefit
One of PayPal's growth drivers is the reacceleration of e-commerce. Shoppers are embracing the omnichannel concept and integrating physical and digital shopping. Total retail sales worldwide are expected to grow at a compound annual growth rate (CAGR) of around 4% through 2025 according to Statista, but e-commerce sales are expected to increase at a CAGR of around 11% through 2027.
PayPal now has a full suite of financial services products that encompass both in-store and digital shopping, including PayPal as a payment option on millions of merchant websites and on physical hardware like point-of-sale devices. As the dominant player in e-commerce, it stands to benefit from a return to e-commerce, perhaps more than any other company. But it's also well-positioned to grow as it expands its omnichannel services.
3. PayPal's direction is already changing
PayPal got a new CEO this year, and there are already changes happening. CEO Alex Chriss has been remaking the executive team, and the company could look a lot different in the coming years.
One direction PayPal was already taking before Chriss' new role was focusing its resources on active customers. Total customer accounts have been decreasing over the past three quarters while sales increased. PayPal is letting go of inactive customers to generate more revenue from those who are already highly engaged. Transactions per active customer increased 13% year over year in the third quarter, and total payment volume increased 15%.
Chriss noted that due to its size and scale, PayPal's mission and focus have become more complicated, leading to the pressure it's been experiencing. He's currently examining the business from top to bottom, and you can expect updates already in the fourth-quarter report.
This adds an element of risk to owning PayPal, but it's small. PayPal is the leading company of its kind, and its fundamental operations aren't changing. Investors look forward to and embrace improvements that should set PayPal on a more focused path.
