PayPal (NASDAQ:PYPL) produced consistent results on Nov. 8, showing that its Q3 revenue was up 13% year-over-year (YoY) to $6.18 billion. But more importantly, its free cash flow (FCF) surged 20% to $1.29 billion. This is really important since it implies that PYPL stock could be significantly higher over the next year.
In fact, PYPL stock has drifted down, both before the earnings and after the earnings release. The stock is down over $100 from its peak of $308.53 on July 23 to $208.30 on Friday, Nov. 12. That’s a drop of 32.5%, which is pretty significant in just over 3 months. This also presents a huge opportunity for value investors.
PayPal’s Free Cash Flow
As anyone who reads my articles on InvestorPlace knows, I like to focus on FCF as a measure of a company’s financial health. The reason is it cuts through all the BS with GAAP earnings and official company press releases.
For example, only those firms that truly generate more cash out the door than they spend have any chance of paying dividends in the long run. They can also afford to buy back their own stock. In addition, FCF-producing companies can make acquisitions, reduce their debt and pile up the cash on their balance sheet.
And there is one more thing that is very important about truly FCF-positive companies. They usually publish their exact FCF number, even on a quarterly basis. This is what PayPal did in its press release. On page 3 of its slide deck, PayPal shows that its FCF of $1.29 billion was up 20% YoY.
This represents a huge percentage of its revenue. If we divide the $1.29 billion in FCF by Q3 revenue of $6.18 billion, it shows that its Q3 FCF margin was 20.9%. PayPal has been consistently producing a 20% plus FCF margin.
For example, in the last 12 months (LTM) its FCF was $5 billion, according to Seeking Alpha‘s cash flow page. This represented $20.4% of its $24.569 billion in LTM revenue. We can use this FCF margin performance to value PYPL stock.
Estimating PayPal’s Value
Analysts surveyed by Seeking Alpha estimate that PayPal will enjoy higher revenue next year. The average estimate of 45 analysts is $30.48 billion in revenue for 2022. That represents an increase of 20.1% over this year’s estimate of $25.36 billion. But more importantly, we can use this to estimate its free cash flow going forward.
For example, given its average 20.5% FCF margin, we can estimate that PayPal will produce $6.25 billion in free cash flow next year. That is a very large amount of cash flow that the company can use to pay a dividend, buy another company or buy back its shares. Or it could just pile up on its balance sheet.
But in any case, the stock market will use that FCF figure to value the company. For example, historically PYPL stock seems to trade around a 2.1% FCF yield. This can be seen by dividing the $5 billion in LTM FCF by its Nov. 12 market cap of $237.37 billion. That works out to 2.1%.
Going forward, I estimate the market will improve this FCF yield to 2% or lower. For example, if we divide our 2022 FCF estimate of $6.25 billion by 2%, the target market value is $312.5 billion. That is 31.65% over Nov. 12’s market value of $237.37 billion.
So our best estimate for PYPL stock is that it could be worth $274.22 per share, or 31.65% over its Nov. 12 price of $208.30 per share.
What to Do With PYPL Stock
There’s always a good reason why a stock is cheap. PayPal has been dropping since its revenue fell short of analysts’ expectations. In addition, the company’s guidance for Q4 revenue was for 12% to 14% YoY gains. In addition, its 2021 guidance for revenue of about 18% apparently did not inspire enthusiasm for analysts, according to Seeking Alpha.
But here is how value investors look at the situation. PYPL stock is cheap for good reason, but it still represents good value going forward. I have shown that its inherent value is 32% higher at $274 per share. And there seems to be a good likelihood this could happen over the next year. So, value investors are likely to stick with PYPL stock.
On the date of publication, Mark R. Hake did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Mark Hake writes about personal finance on mrhake.medium.com and runs the Total Yield Value Guide which you can review here.
