Why You Should Buy PayPal Stock Instead of Square Stock

If you’re deciding where to put your money, Square (NYSE:SQ) is not the better buy compared to PayPal (NASDAQ:PYPL) stock. Why do I think this? In short, even though Square is growing faster than PayPal, it is less profitable.

Why You Should Buy PayPal Stock Instead of Square Stock

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Because of that, Square stock is more expensive than PayPal stock.  Even though PayPal’s market value is $120 billion and Square’s is $29 billion, PayPal stock has much more attractive EV-to-Revenue, EV-to-EBITDA and FCF Yield metrics.

Always buy the cheaper, more profitable company.

Gross Payment Volume and Take Rates

Both companies make significant transaction-based revenue by charging a “take rate” on the gross payment volume (GPV) of transactions from their payment systems’ platforms. In the last 12 months, PYPL had $676.2 billion in GPV, whereas SQ produced $100.5 billion in GPV.

So PayPal processed over 6.7 times the GPV than Square, though PYPL’s stock market value is only about four times larger than Square stock’s market value.

The market seems enamored with Square’s GPV and revenue growth, especially compared to PayPal. For example, in the 12 months leading to Sept. 30, Square reported that its GPV had grown 26.4%. Square “takes” 2.9% of those transactions as revenue.  Non-transaction revenue accounts for 36% of total revenue. But total revenue grew by 45% in the past 12 months.

Growth Rates in Revenue Over the Last 12 Months

But PayPal’s GPV grew slightly slower, at 23.5% over the past 12 months. Moreover, its take rate is significantly lower at just 2.5% in the same period.  This resulted in a much lower revenue growth rate of 13.8% in the last 12 months for Q3 2019.

Moreover, PYPL’s take rate fell from 2.7% to 2.5%. Square’s take rates were much more stable than this.

So, Square stock has a higher valuation compared to PYPL because of its GPV and revenue growth rates, and more stable take rates.

But, of course, this is understandable, since Square’s GPV and revenue base is significantly smaller than PYPL’s. Square is growing faster since it has a lower base to measure that growth.

What Growth Rates Really Imply

The Wall Street Journal recently pointed out that Square’s revenue and transaction volumes are “decelerating.” But they failed to point out that the absolute growth numbers are so high that revenues will continue to grow quite significantly.

For example, Square’s GPV grew 26.5% on a run-rate annual rate in Q3. Here is what that means. In three years, if that rate continues, Square’s GPV will more than double — rising by 102.2%. So its existing GPV will double to $203 billion. If its take rate stays at the same, then transaction-based revenue will also double.

That is very significant. Square stock trades at 6.7 times revenue today. But in three years, with this growth in revenue, the EV-to-revenue ratio will fall significantly to just 3.2X.

This, of course, assumes Square stock does not rise during that period. That is not likely given the company’s growth rates.

Valuation Differences Between Square Stock and PayPal Stock

I recently wrote an article in Seeking Alpha where I discussed PayPal stock’s upside. I feel that PYPL will be worth between $168 and $212 over the next five years, given its high profitability. This implies an annual ROI for investors of between 9.5% and 15.5%.

The simple fact is that Square is much less profitable than PYPL. For example, Square’s adjusted EBITDA margin is 10.6% and its FCF margin is 1.6%. But PayPal’s last 12 months’ EBITDA margin is 51% and its FCF margin is 21.7% over the same period. So PYPL’s profitability far exceeds that of Square.

As a result, PYPL stock is much less expensive than Square stock. For example, PYPL trades at a ratio of EV/adjusted EBITDA of just 14 times, whereas Square stock trades at an EV/Adj. EBITDA ratio of 55 times.

Moreover, compared to PYPL, Square is more expensive on an FCF basis. PYPL stock has an FCF yield of 3.6% (i.e. FCF dividend by the stock market value). But Square stock has a much lower FCF yield to investors, just 1.64%.

Bottom Line: Pick PYPL Stock Over SQ Stock

You will always be better off picking a cheaper stock, even though its growth rates are lower. In this case, that means picking PayPal stock over Square stock.

It may turn out that as Square’s growth decelerates, it may become more profitable. The company will not then have to spend as much on acquiring revenue. It can lay off people that were used for that effort. Its productivity may improve over time.

But it is still tempting to consider a higher growth stock like Square stock. For example, Square’s new Cash App is significantly adding to its GPV growth rates. It is also very popular. PayPal’s Mobile Cash app does not appear to have added to its GPV as significantly as Square’s Cash App.

On the other hand, these apps presently account for less than 4% of both companies growing GPV’s. They are not yet that significant a factor in growth comparisons.

Bottom line: stick with the more profitable, larger and cheaper stock, and go with PayPal over Square stock.

As of this writing, Mark Hake, CFA does not hold a position in any of the aforementioned securities. Mark Hake runs the Total Yield Value Guide which you can review hereThe Guide focuses on high total yield value stocks. Subscribers a two-week free trial.


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