Valuation Is Starting to Be a Concern for PayPal Holdings Inc

PYPL stock is losing its favorable risk-reward asymmetry

Another quarter, another double beat from PayPal Holdings Inc (NYSE:PYPL), another rally for PYPL stock. It was up more than 5% in early Friday morning trading and is still up more than 3%.

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That marks three consecutive quarters of double beats for the digital payments company. In fact, PayPal hasn’t missed on earnings ever since it spun off from eBay Inc (NASDAQ:EBAY) back in July 2015.

Since then, PYPL stock has gone from under $40 to an all-time high above $70 today.

The catalyst? Digital payments are hot. Mobile payments are hotter. And Venmo is hottest.

All three of those growth engines have secular growth potential and will likely provide big revenue tailwinds for PayPal into the foreseeable future. But PYPL stock now trades at a healthy premium to that growth potential. Almost too much of a premium.

Although I’ve been bullish for a while, I’m finally selling on this rally. The stock no longer offers more bang for your buck than the market, and I think that skews the risk-reward profile to the downside for the time being.

PayPal’s Accelerating Growth Narrative

It was a monster quarter for PayPal that underscored the “accelerating growth” thesis.

The total volume of dollars flowing through PayPal is growing at its fastest clip in recent memory. Total payment volume rose 30% this quarter. It was up only 26% last quarter and 25% for the prior two quarters.

Moreover, the total number of transactions happening with PayPal is also growing at its fastest clip in recent memory. The number of payment transactions rose 26% this quarter. That number has trended around 23% for the past three quarters.

Every PayPal customer is also now more active than ever before. The number of payment transactions per active account was 32.8 this quarter, up from 32.3 last quarter and 32 the quarter before that.

Overall, quarterly revenues rose 22%, faster than the 19%-20% growth rates PYPL has posted over the past several quarters. Earnings rose 31%, up from a 27% growth rate last quarter and a 19% growth rate the quarter before that.

Clearly, this is an accelerating growth narrative.

The catalyst for that acceleration is mobile payments.

Mobile payment volume in the quarter surged 47% higher to $24 billion and represented more than a third of PayPal’s total payment volume. The big growth engine in mobile is Venmo, the company’s mobile-facing social payments platform, which saw total payment volume nearly double year-over-year. 

All the while, operating margins are expanding. There is a big partnership with Microsoft Corporation’s (NASDAQ:MSFT) Skype in the pipeline. The Mastercard Inc (NYSE:MA) partnership is expanding to more countries. All in all, the growth story looks really, really good.

What About PYPL Stock Valuation?

But valuation is now a legitimate concern for PYPL stock.

Revenues are expected to grow somewhere around 20% this year versus 17% growth last year. It’s reasonable to say that high-teens to low 20’s top-line growth is here to stay considering secular tailwinds in digital (and specifically mobile) payments.

Earnings, meanwhile, are expected to grow roughly 25% this year versus 17% growth last year. Considering the robust top-line growth narrative and the company’s continued ability to grow margins, it looks likely that PYPL will be able to grow earnings around 20% per year for the next several years.

But with EPS expected at $1.84 this year, PYPL stock is trading at 38 times fiscal 2017 earnings estimates. A 38-times multiple for 20% growth seems awfully full. That is a price-to-earnings/growth (PEG) ratio of about 1.9.

Meanwhile, the S&P 500 is trading around 19.7-times 2017 earnings estimates for growth of about 10-11%. That is also a PEG ratio of about 1.9.

Bottom Line on PYPL Stock

It no longer offers investors more bang for your buck than the broader market. Consequently, despite an accelerating growth narrative, I think the risk-reward profile on PYPL stock skews towards the downside. I’m using this rally to do some profit-taking.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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