To The Moon

In Timing the Market, I recommend a long position on PayPal (NASDAQ:PYPL) over earnings. While PYPL did pop as much as 13% on earnings, to the benefit of Timing the Market subscribers, it pulled back quickly, then consolidating (trending sideways), bestowingno real benefit to investors. Now, PYPL has pulled back to where it is currently trading below my recommended entry price.

Today, as requested, I want to take another look at PYPL to determine whether this is a good entry point.

The Earnings Call

Let's start with a quick recap of the earnings play. The play was highly based on seasonality. Just from a seasonal perspective, being long PYPL overQ1 earningsis a winning trade.

This trade has an 83% win rate. The average upside movement is nearly 12x larger than the downside movement, and so we have the rare "Phoenix" type of earnings trade here: Both probability and risk/reward profile are in favor of the bulls.

Just holding over the month covering Q1 earnings gives 14% of the annual gains, 6% more than expected. Essentially, PYPL moves up two times as quickly as expected over Q1 earnings reports. AsMandelbrotwould put it, market time moves faster over PYPL's Q1 earnings.

We noted also that themax painfor the closest options expiring after the earnings report is bullish. I calculated an expected movement of $10.80 from the cost of the at-the-money straddle: Both puts and calls for Apr29 were trading at $5.40, and the cost of the straddle is just the sum of these two option prices. After looking at the actual movement, we find that the options market pricing in a $10.80 move was pretty much right on the money.

Moreover, the previous quarter being a miss in EPS makes PYPL more likely to rally in the case of a meet or beat:

Estimize

PYPL indeed met its EPS expectations, and the stock rallied. This wouldn't normally be the case, but last quarter's miss allowed a special earnings-play opportunity. I recommended buying the Jul15 $85 calls, which rose by about 100% in value on the day earnings was reported.

This play worked out, but only if you were playing earnings. If you were a PYPL investor, you would have seen stagnation, followed by PYPL tanking along with most other stocks in the early-May selloff.

What Now?

You can think of an earnings report as a sort of Mandelbrothyperbolic time chamberfor market time. Usually, the market slowly adjusts a stock price as new information is released continually over the year. However, an earnings report is like an intravenous injection of novel information that requires immediate adaption.

Still, just as with a body's reaction to an injection, the market still must make some post-injection adaptions. The earnings call is particularly important, in my studies of the market, in that they broadcast management sentiment for the coming quarter. I have run many studies on management sentiment changes as calculated through earnings calls to find sentiment an important predictor of stock price leading up to the subsequent earnings report.

In my research, I employfinancial lexical analysison earnings calls to arrive at a sentiment score, which is - in short - the difference between optimistic forward-looking statements and pessimistic forward-looking statements, normalized for the length of the earnings call. I have done exactly this for PayPal's earnings calls, including that of the most recent quarterly report. This quarter showed a 26% increase in sentiment score, quarter-over-quarter, and a 7% increase year-over-year.

While the 7% increase year-over-year doesn't seem all that impressive, when you plot the story of PYPL's sentiment over the past year, you'll see things in a different light. The last year saw sentiment fall sharply, starting with Q2's earnings call. Ever since the stock has fallen with sentiment but this quarter marks a return to optimism that we have not seen all year:

StockCharts

Positive Catalysts

Overall, the earnings sentiment is a bullish signal for PYPL over the coming quarter yet remains but a metric on its own. To understand things from a more fundamental level, let's take a look at a few of the statements flagged for positive sentiment. This should help us to understand why thecurrent earnings callwas bullish for this company.

"We think we have the lowest loss rates of the Buy Now, Pay Later industry, probably the highest approval rates because we know so many of the customers and a really powerful value proposition to merchants."

- In a non-inflationary environment, debtors win, while creditors lose. But once we enter a time of inflation, it's good to be a creditor. PayPal's business over the past decade has been uphill from this perspective. Now that we are seeing high inflation numbers and interest rate increases, PayPal should see excess returns as a creditor. While other companies are facing excess costs due to inflation, PayPal has at least one countermeasure via its successful Buy Now, Pay Later system.

"Pre-pandemic, we were in the process of simplifying our operating model and enhancing our operating efficiency. The pandemic forced us to put many of those initiatives on hold to simply scale the business and support the unprecedented growth on our platform."

- One reason PYPL hasn't seen much upward buying pressure is the expectation that the company cannot see the same type of growth going forward as it did during the pandemic. Of course, this is true, but another way to think of the slowing growth is PayPal returning to its pre-pandemic business plan, which was highly accepted even without the pandemic-bonus, at least according to the stock prices that the market was accepting for this stock. We are most likely looking at an inflection point for PayPal to return to a more sustainable business operation strategy and should thus be focused on efficiency, margins, and the like instead of pure growth. I think the market will eventually catch up with this idea, and we will see PYPL return to - at least - its pre-pandemic market-accepted price range of over $100 per share.

"And our integration plans with Amazon are progressing, with the back half of the year as our current launch time frame."

- This is another bullish catalyst that - in my opinion - is being highly discounted. Besides the obvious benefit of Amazon users employing PayPal more often, the integration itself has led to the design of important financial service tools that are set to greatly benefit PayPal's bottom line. For example, over half of PayPal users are now using the PayPal digital wallet designed to be used with Amazon. The installation of the digital wallet app has led to 25% more transactions. Moreover, the digital wallet is a marketing tool for PayPal's new financial services, such as the aforementioned Buy Now, Pay Later.

"The first quarter of 2021 was the strongest in our history, with 31% spot revenue growth and 84% non-GAAP EPS growth."

- Clearly, the market either hasn't properly priced in this growth or is discounting future weakness. At the very least, this quarter's results should have a beneficial impact to the company's balance sheet, and so I would expect the stock price to be higher now than prior to the earnings report. Moreover, as pointed out above, PayPal has several bullish catalysts in the coming year. Ultimately, from both a financial and fundamental viewpoint, I consider the market having not adequately priced in the novel information released in this quarter's earnings and earnings call.

Conclusion

My last sentence sums up my thoughts: PayPal is underpriced given the novel information that was released over earnings. Earnings sentiment also points to upward drift over the coming quarter. June happens to be a strong month for PYPL, and so we will be considering adding PYPL to our June seasonal portfolio.