- Based on its longer-term narrative of enhancing the digitalization of commerce and business, PayPal (PYPL) stock is a relevant buy.
- However, the nearer-term headwinds demand your respect, particularly because the paradigm of the consumer economy has changed.
- If you’re patient, get ready for big discounts on PYPL stock.
Whether you’re an educated futurist or simply someone who recognizes basic trends and patterns, PayPal (NASDAQ:PYPL) on the surface is an amazingly relevant investment due to the underlying digitalization of business transactions. More likely than not, the world will embrace a digital future, not an analog one, thus making PYPL stock a buy. However, that’s a two-dimensional way of looking at the picture.
Expand the framework and one quickly realizes that the economic underpinnings must be healthy and robust; otherwise, digitalization doesn’t mean much. It’s akin to a thirsty individual sucking water through an extremely thin straw. And that’s the main issue with PYPL stock. The straw that is the economy isn’t completely closed off but is certainly tightening.
In this case, the numbers don’t lie. Prior to the April 27 session — and ahead of the company’s financial results for the first quarter of 2022 — PYPL stock has dropped 57% on a year-to-date basis. Over the trailing year, it’s down 69%. Most conspicuously, it’s trading at levels not seen since the spring 2020 doldrums, back when the coronavirus pandemic first capsized the global economy.
In my view, you just don’t lose that kind of valuation without fundamental concerns affecting the organization. For PayPal, the “good” news is that these concerns are not native to the business. But the bad news is that, for now, it doesn’t matter.
PYPL Stock and the Deteriorating Consumer Economy
Without the benefit of the Q1 report, I don’t have the greatest visibility into PayPal’s most recent business profile. However, to make my case, I don’t need it. As has long been the case, transaction revenues overwhelmingly dominate the company’s total net sales. On the other end, value-added services represent a relatively small portion of total sales.
In other words, PYPL stock depends on people buying stuff through the underlying payment network. Naturally, demand for various products and services correlates with society’s supply of discretionary funds and its capacity to redirect them as it sees fit. PayPal has been a leading brand in the online-commerce space, so there’s no internal problems here. Rather, the issue is external.
In an analysis I conducted for Barchart.com, I mentioned a dynamic which I termed the San Diego indicator. Being an international port city with a strong economy and a desirable destination status, San Diego is a useful benchmark for other economically successful American cities.
In my research, I mentioned that in 2008 — obviously before the full weight of the Great Recession crashed down — the ratio between apartment rental prices in San Diego versus the median household income was 26%. Between the years 2015 through 2019, this metric increased to 35.5%.
Today, I estimate that the rent-to-income ratio is 40% or possibly higher. That leaves very little discretionary funds available to shop online, which cuts into PYPL stock.
Inflation Kicks PayPal While It’s Down
Now, the other external headwind for PYPL stock is of course inflation. Soaring consumer costs were already a problem before Russia invaded Ukraine. Months after the initial belligerence, inflation for virtually every product sector has sadly become the norm.
Unfortunately, this circumstance is pouring gasoline into a raging inferno. According to data from the Bureau of Labor Statistics, energy costs jumped 32% year-over-year in March 2022. You also have food that has jumped 8.8% and all items under major product categories increasing an average of 8.5%. Essentially, these increases represent a tax on top of the outrageous spikes in rentals — and by deduction from soaring home prices, monthly mortgage payments.
In the analysis mentioned earlier, I stated that mortgage lenders generally prefer to see applicants have a total debt-to-income ratio of less than 36%. Essentially, the data today suggests that even before other debts and expenses are considered, households are spending 40% (or more) to keep a roof above their heads.
So then, it shouldn’t be too surprising that PYPL stock is crumbling. In the years prior to the 2008 global market crash, it wasn’t unusual for households to pay only 15% to 23% of their income on rent or mortgage payments. At 40%, you’re going to have sustainability problems.
Don’t Get Too Cute With the Aphorisms
Because of the meme-stock phenomenon, it’s tempting for investors to adopt a contrarian approach. After all, didn’t Warren Buffett say be fearful when others are greedy, and greedy when others are fearful?
Yes he did but at the same time, he uttered those words during a period where people in major metropolitan areas were not spending 40% of their income on rent. Stated differently, retail investors had more money to be greedy when others were fearful.
Today, folks are simply fearful because their discretionary outflows are limited by myriad factors: inflation, war, supply chain disruptions, pandemic resurgence, on and on. So the nearer-term trajectory for PYPL stock appears to be negative.
Now, I did say that internally, PayPal seems a solid bet. Thus, if you’re patient, you can probably look forward to multiple sessions of intriguing discounts.
On the date of publication, Josh Enomoto 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.