Don’t write off PayPal shares just yet

PayPal (Nasdaq: PYPL) shares have crumbled by nearly 70% over the past year. Once of the brightest stars that could do no wrong in the fintech sector, the stock has suffered as investors have fled expensive growth stocks. And a recent PR disaster has only exacerbated concerns about its growth potential.

In the past few days, the firm published a policy that would have fined users $2,500 for spreading “misinformation”. It was forced to backtrack almost immediately, but the damage has already been done. The stock dropped a further 5% after this debacle.

PayPal shares are under pressure

The company cannot afford to erode trust in its network. PayPal earns almost all of its money from enabling people to make payments to friends and family locally and overseas; and from merchants who let people pay them via its platform.

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It has been successful because people can store and receive money at PayPal even if they don’t have traditional bank accounts, while it is often cheaper for individuals and businesses to send and receive payments with PayPal than via traditional transfers and credit-card payments thanks to the company’s sheer scale. It’s also considered much safer than entering your card details – including that all-important three-digit security number on the back of a card – on multiple web pages every time you make a payment as PayPal can just debit directly from your registered bank account or credit cards to complete payments confidentially.

Over the ten years to 2021 compound sales and pre-tax profit growth was well into the high teens, powering PayPal shares higher.

After the group’s flotation in 2015, the price rose more than sixfold to peak at $300 in 2021, when excitement about e-commerce growth during the pandemic lockdowns was at its apogee. But since then the stock has fallen back below $90.

Regaining focus

It now looks worth buying.

For starters, PayPal is no broken company. The highly-rated growth stock was severely punished because it overpromised, lost focus and couldn’t deliver.

As the pandemic boosted digital businesses, PayPal’s ambitions grew. Its to-do list expanded quickly and featured forays into cryptocurrency, in-store payment facilities and buy now, pay later instalment plans, alongside a bigger push into international markets.

In the meantime, the board was talking up the numbers. By 2025, it said, sales and cash flow would double to $50bn and $10bn respectively while the number of active customers would reach 750 million. Unsurprisingly, with management projecting such impressive growth, investors rushed to snap up PayPal shares.

By February 2022, the group was reining in its big targets and warning about near-term profit expectations. It was a dramatic reversal and the market brutally punished the shares.

Trust takes time to rebuild and the recent PR issues have hurt this recovery story.

Reasons to be positive about PayPal shares

Yet PayPal remains a profitable, cash-generative business that keeps growing. Revenue is expected to rise by 9% to $28bn this year. The company has said earnings per share for the year will be higher than previously indicated, eclipsing analysts’ forecasts.

Moreover, there is now more emphasis on core products and services rather than distractions such as offering online stock trading, for example, which has proved to be a lockdown fad. Cost-cutting is helping bolster margins, with savings of $900m coming through this year and $1.3bn next.

Meanwhile, active accounts have risen to 429 million and US$340bn of payments were processed in the last quarter. PayPal’s market position is strong and although fintech is undeniably a very competitive sector, PayPal can leverage its formidable brand prominence and active customer base. To cap all that, it introduced a major new $15bn share-buyback plan, which should boost earnings per share growth.

Note too that Elliott Investment Management, a big activist investor seeking to unlock shareholder value by working alongside management, has taken a stake worth $2bn in PayPal shares and will be keeping a close eye on the company’s progress.

The over-optimistic growth targets set when technology adoption was booming during lockdowns are now behind us, and the share price has been reset.

Today’s valuation is lower than it has ever been for this double-digit growth stock. PayPal shares can outperform over the medium to long term from this level.