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How to Read the Headlines on PayPal Holdings' Third-Quarter Earnings

By Alex Dumortier, CFA - Oct 29, 2015 at 1:02PM

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The media and the market are focusing on two numbers from PayPal's third-quarter earnings report, but that's a narrow lens.

U.S. stocks are slightly lower on Thursday afternoon, with the Dow Jones Industrial Average ( ^DJI ) and the S&P 500 ( ^GSPC 1.42% ) down 0.20% and 0.06%, respectively, at 12:45 p.m. EDT. Shares of payments company PayPal Holdings Inc are underperforming, down 1.74%, as traders react with disappointment to the company's first post-eBay earnings report (see below).

Image source: PayPal Holdings Inc.

Just going by the headlines, you'd think payments company PayPal's first earnings report since splitting from eBay Inc at the beginning of July was pretty rotten. Here's a sample (my emphasis):

PayPal Misses Revenue Forecasts in First Earnings Report Since EBay Split (Forbes)

Ebay Exceeds Expectations While PayPal Flops (Bloomberg)

PayPal stumbles in first earnings after splitting from eBay (Fortune)

But here's a dirty secret about the way financial journalism works: Headlines need to be concise and punchy. Okay, that's pretty obvious, and it's hardly unknown to readers; however, the effects are a little more insidious.

As a result of those twin imperatives, the most effective headline strategy is to choose a positive or negative angle and overstate it. That's how you end up with headlines that shout "Dow plummets!" to describe a 2.5% decline.

The reality is typically too complex to be well-captured in a pithy black-or-white statement. Unfortunately, those headlines color the way we read an article, and that's assuming we read it at all instead of simply moving on to something else and just remembering the headline.

Here's another dirty secret: Most (but not all) financial journalists have neither the training nor the time to independently analyze an earnings report.

The easiest thing for a journalist to do is to look at the stock price, and then go looking for any evidence that might explain the stock price reaction. That is news -- of a sort.

However, even if the evidence that is unearthed explains the price reaction, it doesn't necessarily justify it -- that's a crucial distinction (the market has been known to overreact or misinterpret breaking news, after all).

Making that distinction is where journalists (or analysts) could add a lot of value, but for the most part, they aren't in that line of work.

(There are some exceptions, including the Financial Times' Lex column, Reuters Breakingviews, The Wall Street Journal's Heard on the Street and...The Motley Fool.)

Now, back to PayPal. From all of the data relating to the third quarter, the financial press and the market appear to have singled out two (negative) things today:

  • The company missed the consensus estimate for revenues, with $2.258 billion versus $2.276 billion.
  • PayPal's "take rate," the average fee in percentages terms it receives for processing transactions, declined from 3.24% from 3.39% in the year-ago quarter.

Let me be clear about this: The first of the two is absolutely meaningless in the context of PayPal's long-term value. This is a miss of less than 1% that represents $18 million. The overwhelming likelihood is that this is simply a result of quarterly volatility in operating results.

The decline in the take rate may have some meaning, but it's impossible to tell at this stage, without the benefit of a longer frame of reference.

Here's the bottom line for this financial columnist: The data included in the earnings release, including a 14% year-over-year increase in revenues (+18% on an currency-neutral basis) and a 200 basis point increase in the non-GAAP operating margin, look more than adequate to support the stock's current valuation. At 24.7 times the next 12 months' earnings-per-share estimate, the shares still look attractive (though not as much as they did during their summer swoon, when they traded below $31).

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$4,577.10 (1.42%) $64.06
eBay Inc. Stock Quote
eBay Inc.
$67.48 (1.00%) $0.67
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
$187.15 (4.37%) $7.83

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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