Although a successful industry-leading company, PayPal (PYPL +3.33%) hasn't been the best to its shareholders. The stock has lost 28% of its value in the last five years, while the Nasdaq Composite Index has more than doubled.
But can this fintech stock double in the next five years? This would translate to a 15% annualized return.
It's not totally out of the question. Here's what it would take.
Double-digit growth
PayPal has been benefiting from the rise of digital payments from the time it was part of eBay to today. The popularity of online shopping, coupled with the digitization and globalization of commerce, has also propelled PayPal. There's no reason to believe this trend won't keep boosting the business.
One important metric that needs to grow for the stock to double in the next five years is total payment volume (TPV). This measures the dollar amount of activity PayPal handles in a given period. From $451 billion in 2017 to an annualized pace of nearly $1.6 trillion in the most recent quarter (Q3 2023 ended Sept. 30), the business has clearly been gaining greater adoption.
But why does PayPal deserve to keep succeeding?
For starters, its digital wallet is the most widely accepted in North America and Europe, with nearly 80% market share among the top 1,500 merchants in these two continents. This wide acceptance puts PayPal in a prime position.
Because of the company's more than two-decade track record of successfully handling payments safely and securely, PayPal is a trusted industry name that doesn't go unnoticed. Both enterprises and consumers realize this.
Plus, by operating a two-sided ecosystem that can collect data from both individuals and merchants, PayPal is better able to detect fraud while increasing authorization rates than rivals that only deal with one side of a transaction. Of course, TPV growth must translate into revenue gains also. According to Wall Street estimates, PayPal's sales are forecasted to grow at a compound annual rate of 8.4% between 2022 and 2025, which would be a healthy rate.
NASDAQ: PYPL
Key Data Points
Boosting the bottom line
Besides rising revenue and greater usage of PayPal's payments platform, this business might need to demonstrate that it has operating leverage. This won't be an easy task, mainly because PayPal has failed to do this in the past.
For example, the company's transaction margin has actually shrunk from 65.1% in Q4 2017 to 45.4% in the most recent quarter. A key reason for this is that PayPal's transaction take rate, or the amount of money it makes from each transaction it processes, has fallen over time.
As the payments landscape becomes increasingly competitive, the take rate will likely continue to drop due to pricing pressure. And a valid argument can be made that payments is a commoditized service.
Let's turn our attention to the operating margin. In PayPal's defense, this metric has stayed relatively constant over the years, successfully holding up despite the declining take rate.
However, it can be discouraging because payments networks should benefit from a widening margin. The technological and communications infrastructure is already built out, so every additional transaction should produce a high margin.
Nonetheless, PayPal produces a lot of free cash flow that management uses to aggressively buy back the stock. This helps provide a bump to earnings per share.
Higher valuation multiple
The last piece of the puzzle for PayPal's stock to double is more love from the investment community. Since the stock has been crushed in the past 2 1/2 years, it trades at a cheap valuation, a price-to-earnings (P/E) multiple of just 18.5. That's cheaper than the broader S&P 500.
I have no clue what PayPal's P/E ratio should be in five years, but if revenue and earnings growth remain strong, a higher valuation can provide a major tailwind for the stock price. And this is why I think shares could double in five years.
