Understanding PayPal's Potential: A Comprehensive Analysis and Investment Recommendation

Finance and economics explained simply
Understanding PayPal’s Potential: A Comprehensive Analysis and Investment Recommendation

PayPal (NASDAQ: PYPL) recently reported modest earnings, which might seem uninspiring at first glance. Surprisingly, I am still recommending buying the stock. Wondering why? Well, in my experience, renowned global brands occasionally experience a dip in price, making them appealing when their earnings per share (EPS) are around 10x.

Looking ahead over the next twelve months, I’m not advocating for any extravagant moves, but rather emphasizing the importance of maintaining the stability of PayPal’s multiple, which I anticipate will remain consistent for reasons I will explain shortly.

As I peer into the future, my only concern is that PayPal’s multiple doesn’t decrease further, which I am confident it won’t, based on the points I will outline below.

PayPal’s immediate focus seems to be centered on driving profitable growth while effectively managing costs. The company’s leadership, particularly Alex Chriss, is keen on prioritizing investments in growth initiatives and at the same time streamlining operations through automation and cost management.

Despite acknowledging the existing challenges and areas that need more attention, the company appears determined to leverage its strong assets, including its globally recognized platform, the popularity of Venmo, and robust data capabilities, to enhance customer experience and stimulate business growth.

The emphasis on boosting transaction profit dollar growth and expanding Venmo’s acceptance indicates that PayPal is well-positioned to tackle near-term challenges and set the stage for sustainable growth in the future.

Nevertheless, PayPal faces several immediate challenges that demand prompt attention. One of the key issues highlighted is the necessity of focusing the organization on the most impactful opportunities and prioritizing essential initiatives, as the company seems to be stretched too thin, leading to inefficiencies that might potentially hinder overall performance.

Additionally, the company has acknowledged a decline in transaction profit dollar growth and has lowered its revenue outlook for the upcoming quarter, suggesting a cautious approach considering the current business climate.

This prudent outlook implies that PayPal might encounter obstacles in sustaining its profitable growth momentum, necessitating strategic adjustments to address these challenges.

To elaborate further, the business is projected to continue growing at around the high-single digits. So, why should you consider investing in PayPal now?

The thing is, when new management takes the reins of a company, they are inclined to implement changes sooner rather than later to make their mark. Whether these changes will yield positive results is uncertain, but it’s undeniable that changes are on the horizon over the next twelve months. Given the current state of investor expectations, now might be a favorable time to invest in PayPal.

PayPal is poised to make close to $5 of non-GAAP EPS. Additionally, the company holds approximately $11 billion in cash and equivalents, which increases to just over $15 billion when factoring in its investment portfolio. This is against its $11 billion of debt.

Consequently, PayPal not only has the potential to generate about $5 billion of free cash flow annually but also boasts a robust balance sheet. There’s little room for doubt about that.

Hence, the challenges facing PayPal are not due to a lack of market share or an inability to generate free cash flows. Instead, the primary issue that PayPal confronts is one of investors’ expectations.

Nevertheless, I maintain my belief that PayPal will achieve close to $6 of EPS in 2024. Note that this estimate exceeds the current projections of analysts, as indicated below.

Regardless of whether my prediction holds true or if the analysts’ estimates are closer to reality, the stock is currently valued at 10x next year’s EPS.

For my thesis to prove correct, I don’t expect a revaluation of PayPal’s multiple. I am simply asserting that if PayPal’s multiple remains around 10x forward free cash flow and doesn’t decrease further, this stock presents a favorable risk-reward scenario.

Further evidence that PayPal’s multiple has already experienced significant compression can be observed in the following graphic.

Just twelve months ago, investors were willing to pay double the current multiple for PayPal.

Should investors decide to reevaluate the stock at a higher rate, even slightly, it would be an added bonus, although not necessary for my investment to yield positive returns.

When considering PayPal’s current valuation, it becomes evident that the stock is attractively priced, especially when factoring in its robust balance sheet and consistent generation of free cash flow.

With investor expectations modest and the market already reflecting a compressed multiple, there is ample potential for positive sentiment to drive the stock’s performance.

As the company gears up to implement strategic changes, PayPal appears well-prepared to surpass current market expectations and deliver robust returns for investors in the next twelve months.

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