Paypal Holdings Inc (NASDAQ:PYPL) is at the center of several favorable trends. For one, digital payment companies are among the hottest tech plays out there today. Two, its Braintree subsidiary started accepting bitcoin payments in 2014, which makes PYPL stock a backdoor crypto play. Third, PayPal itself put up some tremendous earnings numbers in 2017.
Add it all up, and PYPL stock is up a stunning 93% over the past year.
Predictably, the bears are complaining that PYPL stock is overvalued. They have some fair points, particularly that competition is growing and that profit margins may start to decline. But don’t overlook the positives. There is plenty of fuel left in the tank to get PayPal stock to $100 in 2018.
PYPL Stock Cons
Competition Remains Intense: PayPal has a strong first-mover advantage. But there are plenty of other competitors trying to upend PayPal’s position.
From private upstarts such as Stripe to big tech titans such as Apple Pay from Apple, Inc. (NASDAQ:AAPL), there is no shortage of digital payment alternatives. Throw in emerging crypto-pay platforms, and it’s hard to judge PayPal’s competitive position more than a few years out.
For many years, payments were a more stable business, with just the credit card networks and a few digital minnows. But the rate of innovation is accelerating. PayPal has a good hand to play, but it’s still vulnerable if it makes any missteps.
Margins May Decline: The rise of aggressive competition may leave PayPal in a vulnerable place. Retailers are starting to see payment processing as a commodity business with many potential suppliers. That means that PayPal may have to cut its rates to keep more demanding customers around.
And on the other end of the spectrum, the credit card networks have struck back. Under duress, it appears that PYPL will be forced to favor the payment rails from Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA) rather than the more cost-competitive bank ACH network.
Expensive Stock: PYPL stock is currently trading at 61x earnings. Even in a frothy market for tech stocks, that stands out as expensive.
It gets better on a forward earnings basis. Analysts see PYPL stock at 35x next year’s earnings. And looking farther out, earnings are expected to grow at 20%/year for the next five years. That would be in line with past results. PayPal has grown earnings at a 20%/year rate since 2012.
However, given the significant competitive pressures the business is facing, investors should seriously consider the possibility of earnings growth stalling out.
If the company can continue to grow at a healthy rate, the PYPL stock price makes sense here. But if growth tapers off, PYPL stock could get killed. When you buy a stock with a PE ratio this high, earnings need to keep beating guidance each and every quarter.
PYPL Stock Pros
More Practical Than Cryptocurrencies: Fellow contributor Josh Enomoto made a great point recently. While bitcoin and rival altcoins are attracting a lot of excitement, they aren’t really ready for prime time.
As Enomoto writes:
“[D]igital payments are being incorporated everywhere. This is no clearer evidence than in the current dynamics surrounding cryptocurrencies. At the time of this writing, all cryptocurrencies are worth over $750 billion. However, bitcoin’s market share has deflated from 100% at the beginning of the journey to 34.3% today. Many reasons exist why this is the case, but a significant factor is practicality. Long story short, bitcoin can’t scale up to its current demand.”
This clearly shows the appetite for new technologies in digital payments. However, given the high processing fees and the delays in clearing transactions with bitcoin, it doesn’t have what it takes to become a mainstream payments solution at this time. PayPal, on the other hand, has years of experience here and is already making big moves in mobile payments, which brings us to our next pro.
Mobile Payments Technologies: PayPal has moved aggressively to head off competition from new payment upstarts. Specifically, it has done so by acquiring numerous smaller companies.
Most importantly, PayPal, then part of eBay Inc (NASDAQ:EBAY), bought Braintree for $800 million in 2013. Braintree allows vendors to sign up instantly and process through multiple payment platforms, including Venmo and PayPal, among others.
Its one-touch technology reduces friction in transactions. And Braintree partnered with Coinbase way back in 2014 to accept bitcoin payments. PayPal got a cutting-edge tech player at a fair price, and it’s starting to pay off now.
Synchrony Deal: PayPal raised eyebrows with its large move into consumer lending in recent years. Like rival Square Inc (NYSE:SQ), PayPal has been attracting more business by extending loans to many of its clients.
This potentially adds another solid profit stream to the business but comes fraught with risk. Had the economy hit a recession, PayPal likely would have taken meaningful loan loss write-downs.
Unlike Square, PayPal has decided to stick to its roots. It found a win-win solution, selling the credit exposure from its consumer lending portfolio to credit card specialist Synchrony Financial (NYSE:SYF).
Synchrony manages credit cards for many retail stores and is a natural partner for PayPal’s efforts. By selling its $6-billion portfolio, PayPal is off the hook for fraud and credit risk, while still getting upside from marketing the lending platform.
Verdict on PayPal Stock
Don’t ignore the bearish points for PYPL stock. If it misses on a quarterly earnings report, it’d be a good time to take profits. Increased competition is coming and will slow down PayPal’s winning streak at some point.
But for now, the stars are aligned for the company. Investors remain intensely focused on digital payments heading into 2018. And with Braintree, PayPal is the biggest dog in the mobile payments sector. Combine that with its strong core business, and PayPal has the ingredients for even more upside over the next few quarters.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
