The recent performance of the S&P 500 indicates significant growth, with the index showing an increase of over 20% as of September 27, 2024. Historically, the S&P 500 has averaged around a 10% annual increase, but this year stands out as above-average with three months still remaining.
Beating the S&P 500 in the long term is challenging, and doing so in a year of strong market performance is even more difficult. However, those who invested in the financial technology company PayPal Holdings (PYPL) at the beginning of the year have seen their investments outpace the market average.
This outperformance is particularly notable given that PayPal underperformed the S&P 500 in the previous three years and even much of the current year until recently. The company’s stock has experienced a significant surge due to several positive developments.
In 2023, PayPal appointed a new CEO, Alex Chriss, after long-time executive Dan Schulman retired. The transitional period initially caused some stagnation as the company delayed major strategic decisions. Chriss’ early tenure faced challenges; his announcement of new features in January did not initially impress investors, leading to perceptions that he had overpromised and underdelivered.
Despite this rocky start, PayPal’s stock resurgence can be attributed to securing several notable partnerships, including a recent deal with Amazon. Starting next year, consumers will be able to access Amazon’s Prime benefits within the PayPal app, enhancing the company’s service offerings for merchants.
Many of PayPal’s partnerships involve processing payments behind the scenes, often without consumers even realizing it. While these unbranded services have boosted revenue, they tend to have lower margins, leading the company to experience a plateau in gross profit despite revenue growth.
Under Chriss’ leadership, there appears to be progress in addressing this issue. In the second quarter of 2024, PayPal saw an 8% year-over-year increase in transaction margin dollars, a metric similar to gross profit. This marked the highest growth in this metric since 2021, signaling a potential positive trend.
Looking ahead, PayPal has other promising initiatives, particularly in the realm of advertising. The company is leveraging its large base of merchant users to offer targeted consumer data and special pricing incentives, aimed at boosting merchant sales and overall business growth.
From an investment perspective, the positive developments in PayPal’s business have contributed to the stock’s rise. Despite past struggles, PayPal remains a significant and profitable entity. Its valuation had dropped to an all-time low from a price-to-free-cash-flow perspective, but even with recent gains, it is still considered inexpensive, trading at less than 13 times its free cash flow.
This low valuation implies that investors are skeptical about PayPal’s ability to grow its free cash flow or use it effectively. However, improving metrics and potential growth drivers suggest that this skepticism may be unfounded. Furthermore, PayPal is utilizing its free cash flow for stock buybacks, which enhances shareholder value.
In summary, PayPal’s stock may have further upside potential if the company’s turnaround efforts continue to yield positive results.
