Sometimes, it’s a smart idea to look at previous winners to identify attractive investment opportunities. The thinking is that past winners should keep winning well into the future.
In the past five years, PayPal (PYPL 0.65%) shares have fallen an eye-opening 34% (as of Jan. 31). This is a huge disappointment, especially when compared to the 111% gain of the Nasdaq Composite Index.
Is there any hope that the fintech stock could reverse course, reward investors, and potentially even double in the next five years? Here’s what it would take.
Growth must be a key factor
PayPal is in a special position because it has two powerful tailwinds working in its favor. One is the proliferation of electronic payments, which this business helped pioneer. The other is the continuing penetration of e-commerce relative to in-person shopping. These two trends should support healthy growth for PayPal over the next five years.
To be more specific, the business will need to continue increasing the total payment volume (TPV) that its network processes. Despite the stock’s performance, growing TPV hasn’t been an issue, as it has soared from $143 billion in the third quarter of 2018 to $388 billion in Q3 2023. There’s no reason to believe this can’t continue for the foreseeable future.
That’s because PayPal is the most widely accepted digital wallet among the top 1,500 retailers in North America and Europe. Being ubiquitous as a checkout option helps drive payment activity.
Moreover, because PayPal has both merchants and individual consumers as its customers, it is able to collect valuable data from both sides of a transaction. The result is both better authorization rates and improved fraud detection.
Speaking more to PayPal’s two-sided platform, the company has a strong competitive position thanks to its network effect. With more merchants and more consumers, PayPal has become increasingly valuable to all stakeholders. This helps to keep existing rivals and new entrants at bay.
A platform like PayPal needs to start benefiting from operating leverage. Payments is typically an extremely scalable business model that should see expanding margins over time, so it can be discouraging to know that PayPal’s operating margin in the most recent quarter of 15.7% is lower than the year-ago period.
I think that for the stock to double over the next five years, earnings will have to rise at a faster rate than the top line. There are some reasons to be optimistic about this scenario.
Alex Chriss, the new chief executive officer, has already made moves that support his comments about driving greater efficiencies across the organization. PayPal recently laid off 9% of its workforce after laying off 2,000 employees last year. This should help to eliminate unnecessary bloat that PayPal might have added over the past few years.
Another factor that could help the bottom line is management’s increased focus on boosting engagement from existing users. The strategy can require much less marketing spend, which can help profitability.
Shareholders can also appreciate PayPal’s friendly capital allocation policy. It had expected to spend $5 billion to repurchase stock in 2023, an activity that can increase earnings per share.
Besides strong revenue growth and an expanding bottom line, there’s another key ingredient necessary for shares to double in the next five years. And that is a higher valuation multiple.
It’s not surprising that, based on the stock’s poor performance in the past few years, it trades at a ridiculously cheap forward price-to-earnings ratio of just 11.1. This proves that expectations for PayPal are extremely low right now.
Should the business start producing results in line with what I discussed, namely strong revenue growth and an expanding bottom line, there’s a very good chance the valuation will be higher in five years, potentially setting the stock up to double.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends PayPal. The Motley Fool recommends the following options: short March 2024 $67.50 calls on PayPal. The Motley Fool has a disclosure policy.