PayPal (PYPL 2.90%) has a more than two-decade history as a leader in the digital payment space. This first-mover advantage has brought PayPal global recognition as a trusted and convenient way to move money around.
However, the stock has been a huge disappointment. It dropped 14% in 2023, and at recent prices, it's 79% below its peak price from July 2021. Investors are hoping that things can improve going forward.
Where will this top fintech stock be in three years? Let's take a closer look at PayPal's potential.
Still the dominant digital wallet
PayPal's long history in the industry means the company's payment services are ubiquitous these days. At the end of 2022, PayPal's branded checkout solution was the most widely accepted digital wallet, with 79% share at the top 1,500 retailers in North America and Europe. There's no reason to believe PayPal won't still have a huge lead three years from now.
But competition is intensifying. The second-most-accepted digital wallet is Apple Pay. Apple's service has an advantage in that it is integrated into iOS, one of the most popular mobile operating systems. Consequently, the tech giant can put its payment option front and center, which is something PayPal will continue to have to deal with.
However, PayPal processed a whopping $1.6 trillion of annualized total payment volume (TPV) in the third quarter of 2023, which shows it has tremendous reach. You can be sure that TPV will be meaningfully higher in three years, should past trends continue.
PayPal has a user base of 428 million active accounts. And although this figure has leveled off in recent quarters, engagement, as measured by transactions per user, continues rising at a double-digit clip.
PayPal will continue to benefit from the ongoing secular growth of online shopping, which today only represents about 16% of all retail spending in the U.S. There's clearly still a long runway.
As the global economy becomes more digitized, it's not hard to believe that cashless transactions will continue to proliferate. As a leader in the space, PayPal is in an advantageous position.
Benefits of new leadership
Unlike many younger fintech companies, PayPal has consistently posted positive earnings. In fact, over the past five years, the business's quarterly operating margin has averaged 15.9%. Viewed in isolation, this is encouraging for investors to see.
But it's worth pointing out that the operating margin hasn't shown signs of expanding. This is where the new CEO, Alex Chriss, could have a huge effect. During his first quarterly earnings call, he talked about how one of the main focuses is not only to drive growth, but to figure out ways to boost operational efficiencies. We've seen a similar playbook across corporate America, where businesses are trying to trim the fat that they added during the pandemic surge.
Should Chriss be successful with this plan, PayPal's earnings could soar over the next three years. This will mean greater free cash flow generation and a much larger amount of share repurchases.
The chance for outsized returns
Just because a company reports strong fundamentals, like PayPal has been and is likely to continue doing, it doesn't necessarily mean that shareholders will benefit from outsized returns. Of course, the stock's starting valuation is a critical factor.
As of this writing, PayPal shares trade at a forward price-to-earnings (P/E) ratio of 10.5. Based on the positive attributes that I discussed above, this depressed valuation seems like an absolute bargain. It represents a huge discount to both the S&P 500 and the Nasdaq 100 Index. And it indicates that investors are still pessimistic about PayPal's prospects.
Consensus analyst estimates call for 49% earnings per share (EPS) growth between 2022 and 2025, which alone would translate to terrific returns for investors should the valuation stay constant. But if we assume that PayPal's forward P/E multiple gets back to its trailing-three-year average of 30, investors will surely see their gains skyrocket significantly higher.
All else equal, a low valuation reduces risk from an investor's perspective, while at the same time adding upside if the business performs well. This gives me confidence that PayPal stock should reward shareholders over the next three years.
