Being a PayPal (PYPL 2.90%) investor has been painful the past few years. If you initiated a position in the summer of 2017, you saw the stock nearly gain 500%, only to crash back down to the same levels at which you bought it. However, back then, PayPal's quarterly total payment volume was only $106 billion versus the $388 billion it processes in each quarter now.
So, how can a stock trade at the same levels despite incredible business growth? It all concerns sentiment and expectations, and PayPal's are incredibly low. However, I think this could all turn around in 2024, making it a great year to own PayPal stock.
PayPal has made many blunders in the past few years
In 2017, PayPal was still a strong pick for a company that could capture the growing mobile payments market. Now, it has clearly lost ground to apps the phone creators champion.
This part of the pessimistic view has weighed on the stock. Another has been PayPal's falling transaction margin. For the second quarter of 2017, PayPal's transaction margin was 56.3%. In Q3 2023, this figure had fallen to 45.4%, a notable decline. This has significantly narrowed PayPal's gross margins.
Data source: YCharts.
A large part of this is the rise of Venmo, one of the most popular peer-to-peer payment services. PayPal has struggled to monetize Venmo, as it doesn't charge fees for the service (unless the user instantly transfers money to a bank). The gains would be incredible if PayPal could figure out how to monetize it. PayPal has also had other blunders along the way, like losing its place as the sole payments processor for online market operator eBay and attempting to purchase the billboard site Pinterest.
This adds up to a company many have lost faith in despite PayPal consistently increasing revenue and profit. As a result, PayPal has transitioned from a growth stock to a value stock, but there is still an investible business here.
PayPal is a great value investment
In Q3, PayPal's revenue rose 8% year over year. While this isn't market-beating growth, revenue isn't everything. With focussed buybacks and improved efficiencies, a skillful management team can turn high-single-digit percentage growth into market-beating double-digit percentage earnings growth.
Fortunately, PayPal has been doing that. While PayPal's earnings per share (EPS) figure declined year over year (due to a one-time boost PayPal had in Q3 2022), its operating margin has widening after dipping in 2022 (which accelerated PayPal's sell-off).
Data source: YCharts
This is also a focus for new Chief Executive Officer Alex Chriss, who stated on PayPal's recent conference call: "We will become leaner, more efficient, and more effective, driving greater velocity, innovation, and impact for customers." If PayPal can expand its margins with steady revenue growth, it might be able to increase earnings growth at a double-digit percentage pace.
PayPal is also reducing its share count because it believes the stock is trading at a deep discount to its intrinsic value. Over the past 12 months, PayPal has repurchased 75 million shares for about $5.4 billion, reducing the shares outstanding by about 5%. By cutting the share count, PayPal guarantees EPS growth of 5.3% if the net income is unchanged.
While that exact interaction didn't happen in Q3, that's what will happen over the long term if PayPal continues on this trajectory. So, PayPal could produce market-beating earnings growth, which should keep its valuation in line with the broader market. However, that's hasn't happened.
Data source: YCharts.
Compared to the S&P 500, which trades at about 25 times trailing and 21 times forward earnings, PayPal's shares are trading at a substantial discount. That makes it a real bargain.
Will PayPal ever return to its former growth stock glory? Probably not. But with these prices and a plan to increase earnings at a market-beating pace, it can still beat the market. I think PayPal will rebound in 2024 because the bar is set quite low compared to the rest of the market.
