To The Moon

$PayPal(PYPL)$

PayPal Holdings, Inc.'s stock has dropped by more than 20% since our previous warning about potential risk factors. While the company recently posted strong Q4 results, we anticipate challenges ahead due to reduced discretionary spending.

PayPal's dominance in branded checkouts is under increasing pressure from competitors, and eBay's performance remains lackluster. A valuation analysis reveals that Return on Equity (ROE) is trailing behind PayPal's Capital Asset Pricing Model (CAPM). Despite the company’s $15 billion buyback program, we are concerned about the diminishing value of risk premiums.

Fundamental Analysis

PayPal reported its fourth-quarter financial results in February, exceeding expectations by surpassing its revenue target by $120 million and its earnings-per-share target by seven cents. The company saw strong growth in both fiscal 2024 and Q4, driven by higher transaction volumes and consistent nominal growth. However, despite these positive results, PayPal's stock has dropped more than 10% month-over-month. While broader market pressures from a widespread sell-off played a role, company-specific risk factors have further intensified the decline. Specifically, concerns over PayPal's unbranded checkout strategy and potential growth challenges have raised investor doubts.

The combination of external market forces and internal challenges can significantly alter a stock's trajectory, making it necessary to reassess the current outlook. With that in mind, let’s dive into a more detailed analysis of PayPal’s current strengths and weaknesses.

Risk And Challenges

The following diagram offers a comprehensive overview of PayPal’s business verticals, highlighting that the company saw growth across all segments in fiscal 2024, with unbranded card processing and branded checkouts showing particular promise.

Despite PayPal's strong 2024 and Q4 performance, we anticipate several challenges ahead, primarily driven by the current environment of weak discretionary spending.

Branded checkouts, a key feature for many e-commerce platforms, rely heavily on discretionary consumer spending, which has been impacted by sluggish U.S. consumer sentiment and global economic growth, likely influenced by the natural economic cycle and the onset of a global trade conflict. Additionally, PayPal faces increasing competition in the branded checkout space from players like Apple Checkout and Shop Pay, creating additional competitive pressures. Given these factors, it’s reasonable to expect some interim challenges for PayPal.

The potential headwinds facing branded checkouts and broader macroeconomic factors could affect other parts of PayPal’s ecosystem. For example, merchant transactions may experience significant declines due to lower volumes, and eBay's performance could also suffer, further slowing the growth of this segment.

Lastly, we anticipate that PayPal's buy-now-pay-later (BNPL) service will face slower growth, given the aforementioned factors and the weakening credit cycle. Rising U.S. delinquency rates and growing global credit risk could put pressure on loan pricing and liquidity access. While BNPL has performed well in a higher-for-longer interest rate environment, we expect it may face a slowdown as credit risk dynamics shift.

PayPal's Market Size Compared to Visa

With over 400 million active customers, PayPal is still only a fraction of Visa’s size, given that Visa has more than 4 billion cards in circulation. However, PayPal benefits from similar positive network effects that drive its growth, particularly in key areas that I believe are crucial to its future success.

Investor Focus and PayPal's Update

That said, investors are always focused on the bigger picture, and some of my members have been asking for an update on PayPal. So in this analysis, I’ll share whether I still consider PayPal stock a buy or if my recommendation has changed based on recent developments. I’ll walk through my discounted cash flow valuation model, assess PayPal’s valuation using a forward price-to-earnings ratio, and review its revenue growth history, cash flow from operations, and return on invested capital. By bringing these factors together, I’ll answer the key question: Is PayPal a buy, hold, or sell?

Revenue Growth Deceleration

Looking at PayPal’s revenue growth over the past decade, one trend stands out: a slowdown in revenue growth since 2020. Revenue growth peaked at over 24% in 2020 and 2021, but has since decelerated, most recently reaching just 4.24%. The company’s CEO, who has been in the role for about a year, has focused on driving more profitable growth. However, he has acknowledged the need to increase spending on marketing and advertising to accelerate revenue growth, as the current pace of deceleration is concerning.

Key Growth Metric: Monthly Active Users

One promising trend, however, is the growth in monthly active users, a key metric that could signal a turnaround. While I don’t expect PayPal to return to its days of double-digit revenue growth anytime soon—if ever—investors should be satisfied if the company consistently delivers revenue growth of 6% or higher, ideally around 8%. Given PayPal’s strong cash flow from operations relative to sales, such growth could generate solid long-term returns for shareholders.

Focus on Profitable Growth

Speaking of cash flow, PayPal’s shift toward more profitable growth has been paying off. The company has strategically focused on attracting higher-value customers—those it can serve more effectively—rather than simply trying to expand its total user base. This is a strategy I’ve always preferred.

Targeting the Right Customers

To illustrate, consider a restaurant in a city. The most valuable customers are the local residents because they are easier to attract and retain compared to those living 20 minutes away. Winning over distant customers requires exceptional service to entice them to return, whereas local customers are more likely to visit simply because of convenience. The same principle applies to PayPal: targeting high-value customers who are easier to serve leads to more efficient marketing, stronger retention, and ultimately, more profitable long-term growth.

Positive Results from PayPal's Strategy

I’ve been a supporter of this strategy, and it’s paying off for PayPal. While revenue growth has not yet reaccelerated, the company’s cash flow from operations to sales has significantly improved, rising from around 13.3% to 23%. Similarly, PayPal’s return on invested capital (ROIC) has rebounded as well, jumping from a low of 7% in 2023 to 13.65%. If this trend continues, I wouldn’t be surprised if ROIC surpasses 16% and even approaches 20%.

PayPal's Asset-Light Model

This improvement is driven by PayPal’s asset-light business model, which requires less capital investment compared to traditional companies. It connects people for transactions and builds the necessary technology and infrastructure but doesn't need significant capital to develop the network. PayPal’s model is scalable, which is a key reason for its potential growth.

Comparing PayPal's Potential to Visa

If you look at the potential for PayPal, Visa provides a useful benchmark. Visa has become highly successful, and if PayPal can achieve just a fraction of Visa's success, it would generate strong returns for shareholders. PayPal currently has around 400 million active customers, while Visa boasts over 4 billion cards in circulation. While this isn’t a perfect apples-to-apples comparison, it gives a sense of how much larger Visa is than PayPal.

If PayPal can eventually reach even a quarter or half the size of Visa at its peak potential, the returns for shareholders would be remarkable. Right now, PayPal is about 10% the size of Visa, and it’s already delivering solid profits. If it grows to 15% or 20% of Visa’s size, it would generate strong returns on investor capital and, in turn, substantial gains for shareholders.

Valuation and Discounted Cash Flow Model

Now, let’s look at PayPal’s valuation. When I ran my discounted cash flow (DCF) model for PayPal stock, I arrived at an intrinsic value of $122 per share, compared to the current market price of $69.40. This suggests that, according to my DCF model, PayPal stock is undervalued.

Additionally, when I assessed PayPal’s valuation using a forward price-to-earnings (P/E) ratio, it appears to be inexpensive, with a forward P/E of 12.34. Whether I evaluate it using the forward P/E or the DCF model, PayPal stock still looks like a good value.

Conclusion: Is PayPal Stock a Buy?

The recent decline in PayPal's stock may attract some investors looking to buy the dip. While I recognize that PayPal could eventually reach a "buy-the-dip" opportunity, I believe there are still fundamental challenges and valuation concerns to consider. As a result,So, to answer the question in the headline: Is PayPal stock still a Buy? I believe it is a Hold.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

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