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Better Buy After the Split: eBay or PayPal?

By Andrés Cardenal - Apr 1, 2016 at 2:21PM

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PayPal is delivering superior growth rates, but eBay is more attractively valued. Which one is a better buy for investors right now?

The separation of eBay (EBAY 5.06%) and PayPal (PYPL 5.96%) is still fairly recent; the two companies started trading independently in July of last year. Let's take a look at how eBay and PayPal are performing after the split and, perhaps more important, which one is a better purchase for investors going forward.

eBay offers value and safety
eBay is delivering uninspiring growth rates, and management fully acknowledges that the company needs to improve performance. eBay reported $8.6 billion in sales during 2015, this represents a 2% decline in U.S. dollars and a modest increase of 5% in constant-currency terms versus 2014. The company is expecting constant-currency sales to grow between 2% and 6% in 2016, so performance will most probably remain subdued in the coming quarters.

Amazon (AMZN 3.66%) is the undisputed growth leader in e-commerce, and the company is willing to operate with minuscule profitability, sometimes even at a loss in a particular quarter, to deliver rapid revenue growth and gain market share versus both online and brick-and-mortar retailers. Amazon produced $107 billion in sales during 2015, with constant-currency revenue growing at an impressive 26% year over year.

Image source: eBay.

eBay is implementing different initiatives to accelerate growth, including building better product catalogs and offering more information for sellers to make the right merchandising and pricing decisions. Nevertheless, management is not willing to destroy profitability in order to better compete against Amazon, and this is an important limitation for eBay in terms of growth. 

The good news is that eBay makes huge profit margins, in the neighborhood of 26% of revenue at the operating level. Besides, eBay stock is attractively valued. The company carries a forward price-to-earnings ratio around 12 times earnings forecasts for the coming year, a significant discount versus a forward price-to-earnings ratio around 17 for the average company in the S&P 500 index.

PayPal for explosive growth
PayPal is clearly firing on all cylinders: The company produced $9.2 billion in sales during 2015, an increase of 15% in U.S. dollars and a 19% jump in constant-currency terms versus 2014. Profit margins are also quite healthy, GAAP operating margin stands at 16% of sales, while adjusted operating margin is in the area of 21%.

The company ended the fourth quarter of 2015 with 179 million active customer accounts, an increase of 11% versus the same quarter in 2014. PayPal processed 1.4 billion payment transactions during the quarter, an annual increase of 25%. The amount of transactions is growing at a faster rate than the user count, so engagement per user is on the rise, a big positive when measuring PayPal's ability to sustain growth.

In addition, management estimates the market opportunity is worth around $2.5 trillion when considering both online and mobile digital payments, so the company is still has enormous room for expansion in the years ahead.

Image source: PayPal.

PayPal's financial performance is nothing short of impressive, and the company seems to be on the right track to deliver sustained growth in the coming years. On the other hand, the company trades at a forward price-to-earnings ratio in the area of 23 times expected earnings, a substantial premium versus the average stock in the market. 

PayPal clearly deserves an above-average valuation considering its performance and growth prospects. Nevertheless, demanding valuation levels are always a source of risk if the company does not deliver in accordance to expectations. 

eBay or PayPal?
Investment decisions cannot be made in a vacuum, it all depends on factors such as your own investment strategy, risk tolerance, and return targets. eBay is a more defensive investment, as the company has a profitable business model, and the stock is trading at fairly attractive valuation levels, which reduces downside risk. However, eBay needs to do better in terms of growth to fully capitalize on its potential.

PayPal is delivering impressive performance, and the company still has a lot of room for expansion in the years ahead. Valuation risk is an important consideration to keep in mind, though, since high expectations are usually hard to beat.

In a nutshell, PayPal is the best choice for growth-oriented investors looking for superior upside potential and with a relatively high risk tolerance. On the other hand, those looking for value and safety should probably gravitate toward eBay.

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Stocks Mentioned

eBay Inc. Stock Quote
eBay Inc.
$48.82 (5.06%) $2.35
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
$85.21 (5.96%) $4.79, Inc. Stock Quote, Inc.
$2,302.93 (3.66%) $81.38

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