Since its founding more than two decades ago, PayPal(NASDAQ: PYPL) has become a leader in the digital payments arena. However, in the past few years, it has become a disappointment for investors.
Shares of PayPal currently trade about 70% below the all-time high they touched in 2021, even though they have soared by more than 40% in the past four months. That combination might have you considering this fintech stock as an investment candidate. But before you decide whether to add PayPal to your portfolio now, here are three things you need to know.
PayPal's various segments
Investors are probably familiar with PayPal as a digital payments powerhouse. But the details of how the business operates shouldn't be ignored.
The company's branded checkout solution -- the system behind the PayPal buttons that consumers see when shopping online -- drove 27% of the total payment volume on its platform last quarter. Recently, the company signed a new deal with Shopify that will let merchants who use its popular e-commerce platform integrate this service onto their websites.
Back in 2013, PayPal acquired Braintree for $800 million and integrated it into its ecosystem as its merchant-focused solution. Last quarter, that segment's total payment volume grew by 11% year over year, faster than PayPal's growth overall. And at 36% of the company's total payment volume, it accounts for a larger share of the pie than any other segment. Braintree, which offers unbranded payment solutions, competes directly with the likes of Adyen and Stripe.
As part of that Braintree acquisition, PayPal also received Venmo, the popular peer-to-peer payment app. Venmo handled $75 billion worth of transactions last quarter. Management is focused on increasing monetization of this unit, and has been promoting its Venmo debit card and the Pay with Venmo feature.
At the end of the day, PayPal's overarching goal comes down to "revolutionizing commerce globally."
PayPal's financial position
Despite what the stock's performance in recent years might suggest, PayPal is a financially sound enterprise. Any payments business that achieves scale can be incredibly lucrative, and this one certainly is.
PayPal is consistently profitable, with an operating margin that typically sits in the mid-to-high-teen percentages. There has been some improvement recently, as the operating margin went from 16.9% in Q3 2023 to 18.8% in Q3 2024.
Management is first and foremost focused on reinvesting earnings back into growth initiatives. These are mainly centered on product enhancements that can boost user engagement.
PayPal's high profitability results in lots of free cash flow (FCF), or what's left of cash flow after capital spending -- it expects this to total $6 billion in 2024. The leadership team plans to use all of it to repurchase shares, boosting the portion of the business that each remaining share represents.
The company also has a sound balance sheet. As of Sept. 30, PayPal had $16.2 billion of cash, cash equivalents, and investments on its books. That more than offset its debt of $12.4 billion. Investors should appreciate businesses like this that produce reliable FCF and have net cash positions, as it greatly reduces their financial risk.
PayPal's current valuation
From the day PayPal spun off from eBay in July 2015 to the stock's all-time high in July 2021, the shares skyrocketed by 740%. That was much better than the returns investors would've gotten over the same period from putting money into index funds that track the S&P 500 or the Nasdaq Composite.
However, since hitting that peak, the stock has tanked. At its low point last year, it was down by more than 80% from that peak. PayPal shares now trade at a forward P/E ratio of about 18 -- an attractive entry point for prospective investors.
Given the company's positive attributes, one might naturally wonder why the valuation is not higher. I think the market is worried that PayPal's growth will be markedly slower in the wake of its pandemic-generated surge, now that shoppers have largely returned to their pre-COVID buying behaviors. Investors are likely also concerned about just how competitive the digital payments landscape has become.
But PayPal continues posting solid revenue and total payment volume gains, and it has been at the forefront of electronic payments for more than two decades. Both of those attributes should give investors confidence about its future.
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Adyen, PayPal, and Shopify. The Motley Fool recommends eBay and recommends the following options: long January 2027 $42.50 calls on PayPal and short December 2024 $70 calls on PayPal. The Motley Fool has a disclosure policy.
