Once a top-performing stock, PayPal (PYPL 1.56%) has become a huge disappointment for shareholders in more recent times. As of April 4 the fintech stock is sitting 79% below its peak price, which was set in July 2021.
But that shouldn't discourage long-term investors. I believe there's a lucrative opportunity here, primarily because the stock trades at a ridiculously cheap forward price-to-earnings (P/E) ratio of just 12.6.
Should you buy PayPal shares right now? I don't think there's any question that you should add the digital payments leader to your portfolio.
Looking at the competitive landscape
If you're considering buying a stock with the intention of holding it for several years, it's important to figure out if the business has an economic moat. This means the company possesses a set of traits that help protect it from competitive forces.
In PayPal's case, it has network effects. By operating a two-sided platform with 426 million active accounts, which include both consumers and merchants, PayPal becomes more valuable to all users the larger it gets. It would be an extremely difficult task for a new industry entrant to develop a competing network from scratch.
PayPal is also able to collect valuable data from consumers and merchants. This leads to improved authorization rates and better fraud detection, particularly when compared to a service provider that only has insight into one side of a transaction.
PayPal's moat is absolutely critical to the investing thesis. That's because the digital payments industry is becoming incredibly competitive. There are numerous compelling options for individuals when it comes to digital wallets or personal finance tools. On the merchant side, it's a similar story with payment processing services.
To continue succeeding, PayPal will need to stay on top of its game. Luckily, Alex Chriss, the new chief executive officer, has already demonstrated his focus on product innovation.
Investors might be discouraged by the declining user base, which might have something to do with the increasing competition mentioned earlier. But the fact that PayPal's total payment volume (TPV) increased by 13% in 2023, to over $1.5 trillion, is a very positive trend. This indicates that users are doing more transactions on the PayPal platform. As we look over the next decade and beyond, the rising popularity of online shopping and electronic payments will continue providing a nice tailwind.
It's good to see that each account is engaging with the platform more frequently. As a larger proportion of the user base comes from these highly engaged consumers, PayPal will likely have to spend less on marketing initiatives, and that could boost margins and profitability.
Stellar financials
If the only information you had was PayPal's stock chart, you'd probably assume the business was posting revenue declines and skyrocketing net losses, while at the same time maybe teetering on the edge of insolvency. That's simply not true. PayPal is a sound financial enterprise, which reduces risk for investors.
When it comes to the balance sheet, PayPal is in fine shape. As of Dec. 31, the company had $11.3 billion of debt on the books. However, it also had a combined $17.3 billion of cash, cash equivalents, and investments. Plus, the business consistently generates billions of dollars in free cash flow each year.
Revenue and adjusted diluted earnings per share (EPS) were up 8% and 24%, respectively, in 2023. The company expects earning to be little changed in 2024, but Chriss has prioritized driving efficiencies across the organization, which in due time should help the bottom line.
In my opinion, the forward P/E shows unwarranted pessimism surrounding PayPal and its prospects. But low expectations, coupled with the possibility of strong financial performance, create the perfect recipe for impressive stock performance. That makes PayPal a smart buy today.
