Why I bought PayPal stock

PayPal stock used to quote above $300, but today it stands at around $72 per share, a drop of more than 75%. In this blog, I will explain why I bought PayPal shares. 

What PayPal does 

PayPal operates a technology platform that enables digital payments around the world. They operate a two-way network that connects merchants and consumers, allowing their customers to connect, transact, send and receive payments online and in person. They also allow you to transfer and withdraw funds using various funding sources, such as bank accounts, PayPal or Venmo account balance. 

The company offers payment solutions under the names PayPal, PayPal Credit, Braintree, Venmo, Xoom, Zettle, Hyperwallet, Honey and Paidy. 

PayPal Business Overview 

2023 Business Review  

PayPal generated $29.8 billion in revenue in 2023, representing 8% growth compared to 2022. Total Payments Value (TPV) was $1.53 trillion, up 13% year-over-year, and PayPal executed 25 billion payment transactions, a 12% increase. They ended the year with 426 million active accounts, down 2% from 2022. In addition, a new director, Alex Chriss, was appointed. 

Review of the last quarter 

In the second quarter, PayPal posted $7.9 billion in revenue, up 8% from last year. Net profit was $1.13 billion, representing a 10% increase. GAAP operating profit increased 17% to $1.3 billion, while non-GAAP operating profit increased 24% to $1.5 billion. GAAP operating margin increased 126 basis points to 16.8% and non-GAAP operating margin increased 231 basis points to 18.5%. 

Total Payments Value (TPV) for the quarter increased 11% to $416.8 billion. The number of active accounts decreased by 0.4% to 429 million compared to the same period last year. The average number of transactions per account increased by 11% to 60.9 transactions per account. Operating cash flow was $1.5 billion, free cash flow was $1.4 billion, and adjusted free cash flow was $1.1 billion. PayPal bought back 24 million shares for $1.5 billion. 

Performance by segment: 

The total value of payments on Branded Chceckouto grew by 6%. Braintrie by 19% and Venmo by 8% 

Guidance

PayPal has raised its 2024 GAAP net EPS (Earnings Per Share) guidance to be somewhere between $3.88 and $3.98, and has also announced that the share repurchase program will be around $6 billion. 

Balance sheet  

As far as the balance sheet is concerned, I have no complaints. Short-term assets are greater than short-term liabilities. Indebtedness is not a problem, since the company has enough money in the account, and if we take into account short-term investments, the company could immediately cover its debt. 

The only thing that somewhat bothers me is quite a bit of goodwill on the balance sheet, but given other assets , this is not a problem. 

Roic and buybacks 

Last year, PayPal bought 5 billion euros of shares from circulation, this year it plans to buy them for 6 billion, compared to the company's current value of $75 billion. 

This means that without buying any additional shares, I will become a larger shareholder than I was before. The buyback of shares from circulation reduces the number of shares in free circulation, which means that the share of ownership of each individual shareholder increases and, consequently, their share in the company's profits. 

Roic

One of the important indicators that tells us how well a company invests capital is ROIC (return on invested capital), the famous investor Charlie Munger said this about ROIC: 

"In the long run, it's hard for a stock to deliver a much better return than the company behind it. If a company generates a 6% return on equity over a 40-year period and you hold that stock for 40 years, you won't get a significantly different return than 6% — even if you originally bought it at a very low price. Conversely, if a company generates an 18% return on equity over a period of 20 or 30 years, even if you paid a seemingly high price for a share, you will end up with an exceptional result." 

PayPal currently achieves a return on invested capital of around 20%, which is pretty good. 

Valuation

In the valuation model, I made three scenarios (normal, bad and great) and then weighed them according to the probability of them happening (normal represents 60% of the final value, and bad & great represent 20% each). In the calculation, I used PayPal's free cash flow, which is just over $6 per share. 

In a normal scenario, I assumed that for the first five years of calculations, PayPal's free cash flow would grow by 7%, and the second five years by 5%. 

In a worst-case scenario, I assumed that for the first five years of calculations, PayPal's free cash flow would grow by 4%, and the second five years by 0%. 

In a good case scenario, I assumed that for the first five years of calculations, PayPal's free cash flow would grow by 10% and the second five years by 7%. 

When I weighed all the scenarios, as I stated above, I got a value of around $95 per share, but since I always add a margin of safety of 20%, I got the value of the stock at around $78 if we want to get a 10% return. 

Conclusion

By all measures, PayPal is a pretty good company, from the user's point of view, it has a good product that protects the user from negligence, but at the same time it is very easy to use. 

As far as business is concerned, PayPal is doing well and getting better. The only metric that I expect to improve in the future is the number of active accounts, mainly that it is growing and not decreasing, everything else is good. 

PayPal's balance sheet is healthy and the company is not over-indebted, it achieves a good return on invested capital, so this means that the money it borrowed was also well invested. 

However, PayPal has also begun very large-scale share buybacks from investors in recent years, which increases the share of ownership in the company and thus a larger share of profits for those of us who remain. 

PayPal's stock is currently selling at an attractive price, as I have shown with my calculation. 

All of these factors combined are why I bought PayPal in the first place, and my average price is somewhere around $65 per share.