- PayPal (PYPL) stock is down over 40% year-to-date (YTD), even as the company reported huge gains in free cash flow (FCF) in 2021 and high FCF margins.
- Moreover, PayPal expects to make 15%-17% revenue growth in 2022 (not including Ebay (EBAY) 19%-21% growth).
- As a result, investors in PYPL stock can expect the stock will eventually move significantly higher as it catches up with its historical valuations.
PayPal (NASDAQ:PYPL) posted excellent results on Feb. 1 for Q4 and 2021. This included 17% year-over-year (YoY) revenue growth in 2021. Moreover, its free cash flow (FCF) grew 38% YoY in Q4 to $1.55 billion. As a result, investors can expect to see PYPL stock move significantly higher this year.
So far this year, the stock is down 42%. However, the good news is that the stock is already up nearly 30% from its low of $93.61 a month ago on March 7.
| Ticker | Company | Current Price |
| PYPL | PayPal | $111.83 |
PayPal’s Powerful Free Cash Flow
PayPal makes money by charging fees on what it calls TPV (Total Payment Volume). That is the gross amount of transactions from items that consumers charge using their PayPal debit, credit and online retail purchases. Its FCF benefits from the leverage effect from TPV growth with relatively stable or slower-growing cost levels.
For example, in Q4, PayPal produced $340 billion in TPV, up 23% on a spot basis, but its FCF grew faster. It was up 38% from $1.22 billion in Q4 2020 to $$1.55 billion in Q4 2021. This can be seen on page 5 of its earnings release. This is what is known as operating leverage. With higher TPV and revenue, FCF grows even faster.
This is what the market seems to be missing about the underlying power of PayPal’s free cash flow. For example, during Q4, the company’s FCF margin rose to 22.4% of revenue, up from 18.3% in Q4 2020. As revenue rises, the FCF margin rises as well, due to its huge operating leverage.
We can use this to value PYPL stock going forward.
What PayPal Is Worth Using Free Cash Flow
If we assume that revenue will grow by 19% to 21% in 2022, as the company predicts, we can also assume that the FCF margin will also expand. I predict that it could rise to 26.88% of revenue by the end of 2022. That is a 20% increase from its 22.4% margin level as of Q4 2021.
But for the whole year of 2021, let’s just assume that the average FCF margin will be 23%. Since analysts now expect that revenue will hit $29.38 billion in sales in 2021, that means FCF will be $6.75 billion in 2022. That is a bit higher than the company is estimating at $6 billion.
We can use this to value PYPL stock. For example, using a 3% FCF yield metric, which is the same as multiplying FCF by 33.33 times (i.e., 1/.03=33.33), the market cap will be $225 billion. That is 58% higher than its present $142 billion market cap, as measured by Yahoo! Finance.
In other words, PYPL stock is worth 58% more. That puts its value at $193.06, or 58% over the closing price of $121.73 (on April 4).
Where This Leaves Investors in PYPL Stock
The average price target of 43 analysts surveyed by Refinitiv (seen at Yahoo! Finance) is $178.28. Although not as high as my estimate, it still represents huge upside in PYPL stock.
Moreover, the average of 39 analysts in the last three months covered by TipRanks.com is $180.63, or 48% upside from the April 4 closing price. In other words, most analysts, like me, believe that PYPL is very undervalued.
One simple way to see this is to look at Morningstar’s historical valuation measures. For example, they report that in the last 5 years, the average price-to-cash flow multiple for PYPL stock is 42.6 times. You will recall that my analysis uses a lower ratio of 33.33 times Price-to-FCF. So this represents a margin of safety in my calculation.
In other words, if PYPL stock eventually returns to just 75% of its normal valuation range, PYPL stock could rise anywhere from 48% (analysts) to 58% (me) higher.
This provides a good expected return for value investors. In fact, we can even measure this over two years. Let’s say that the stock rises 58.6% to $193.06, but it takes 2 years from now. That works out to an average annual compounded gain of over 25.94% each year for the next two years.
This means that PYPL stock can reasonably be expected to rise to at least $153.31 this year and $193.06 by the end of next year. That is a pretty good ROI for most investors.
On the date of publication, Mark Hake did not hold (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.
