Few things are as rewarding as buying a blue chip stock when it’s undervalued and watching it blossom and give your portfolio a spark.
The market can act irrationally, sometimes creating temporary distortions that investors can take advantage of. For example, look at the financial technology company PayPal (NASDAQ: PYPL). The stock price is down nearly 80% from its high, a rare drop for such a household name.
While sharp stock declines often come with a story, I’ll show you why PayPal is remarkably cheap and could help a diversified investor become a millionaire with some due diligence, patience, and good fortune. Here is what you need to know.
Why has PayPal stock fallen? These two charts say a lot
PayPal has its hands in various fintech services, but its core business is digital payments, where it makes money by charging merchants and consumers to power transactions. Its famous brands include PayPal, PayPal Credit, Venmo, and more. In total, PayPal has 433 million active accounts, with more than $1.2 trillion in annual payment volume.
During the pandemic, lockdowns kept consumers out of physical stores and caused a boom in online shopping. As a digital payments company, PayPal benefited from this. You can see below that revenue growth spiked in 2020 and 2021. However, these higher numbers created tough comparables the following year, and growth slowed dramatically. Wall Street hates seeing slow growth, which helps explain the stock’s decline.
PYPL data by YCharts. YoY = year over year.
One important takeaway is that PayPal’s revenue growth slowed but remained positive — it’s not giving up revenue gained during COVID-19. You can see in the chart below that PayPal’s share price is roughly the same as five years ago, but PayPal’s business has more than doubled its revenue since then.
PYPL data by YCharts. TTM = trailing 12 months.
This begins to paint the picture that Wall Street has been too harsh on PayPal, but that’s not enough. One must go deeper to see where there could be an investment opportunity.
Earnings growth and a cheap valuation could be potent
It’s worth emphasizing that PayPal is not some speculative start-up company; it’s a fintech titan that generates more than $28 billion in annual revenue. The company’s size makes it a profitable business that is still growing earnings at a swift pace.
PYPL EPS LT Growth Estimates data by YCharts. EPS LT = earnings per share long term.
Analysts expect the business to grow earnings per share (EPS) by an average of more than 17% annually over the long term. Yet, since the stock’s been beaten down so severely, shares trade at a forward price-to-earnings (P/E) ratio of just 14. I say “just” because the S&P 500, which historically grows at a 10% annual rate over time, trades at a forward P/E of almost 20.
Shouldn’t PayPal command at least that valuation considering its expected growth is nearly double? It’s unclear where the valuation will settle, but the stock’s price/earnings-to-growth (PEG) ratio is less than 1, signaling great value, given PayPal’s growth.
What could PayPal returns look like?
Investors can do back-of-the-napkin math to put some hypothetical numbers to what PayPal stock offers. Analysts believe the company’s EPS will be $4.95 in 2023. To be safe, I’ll assume the company slightly underwhelms and grows EPS by 15% annually over the next five years.
That means PayPal would earn approximately $10 per share in 2028. If the stock were to trade at 20 times earnings that year, shares would trade at $200 — a 190% total gain that would probably outpace the broader market over the next five years. Any outperformance in PayPal’s growth or a higher valuation could create even higher returns.
Will this stock take investors from rags to riches? Probably not. However, as part of a diversified portfolio, hitting steady doubles and triples like this instead of striking out looking for the home run can take you to millionaire status over time.
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Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends PayPal. The Motley Fool recommends the following options: short September 2023 $67.50 puts on PayPal. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
