PayPal Earnings Reveal Undervalued Stock: Here's the Scoop

When investors think of stocks worthy of a second look or even a percentage allocation of their hard-earned capital, the technology sector and its run for artificial intelligence growth might come to mind first. However, not all stocks in the sector are made equal. While most have outperformed, there are still a few names that need to catch up.

Among these is PayPal Holdings Inc. (NASDAQ: PYPL), the online payment platform whose stock price can’t catch a break. Investors can zoom out over the past 12 months of price action and notice two things. The first is that PayPal stock underperformed the broader S 500 during a year when technology stocks supposedly carried all the momentum.

The second thing investors will see in this chart is that PayPal stock has been relatively flat over most of the year, even though the company’s financials demonstrate growth. This suggests that the stock is on the cheaper end of the spectrum. With the second quarter 2024 earnings results out for PayPal investors—and analysts—to digest, it may have proven just how cheap it might be today.

PayPal's Growth Drivers Are Stepping on the Gas

Digging into PayPal's quarterly earnings presentation will reveal more to investors than well-organized slides and corporate lingo. It will also reveal all of the key performance indicators (KPIs) that investors look for when justifying their projections and forecasts for the future.

In the case of PayPal's business model, there are a few to watch out for. First, investors need to cover the common ground of any business: the top and bottom lines (revenue and net income). PayPal's revenue jumped 9% over the year, mainly driven by total payment volume (TPV).

Because of better margins, an adequate budget, and cost controls, PayPal could pass on more from each sale to operating and net income. Operating income grew by 17% over the year, achieving a margin of 18.2% thanks to these practical management efforts.

All told, PayPal reported earnings per share (EPS) of $0.83, or 18.5% above last year's. Now, investors need to get excited. Why is EPS growing faster than operating income? The answer is what everyone is looking for when wondering whether a stock is trading at cheap valuations.

Because the payment volume grew due to a 13% growth in transactions per account and an 11% increase in the number of transactions per account, management now has a better idea of what to expect from PayPal's financials in the future.

Why the Forecast for PayPal Stock is Brighter Than Ever

Using management guidance as a benchmark, investors can expect to see mid to high single-digit growth in EPS and approximately $5 billion in free cash flow (operating cash flow minus capital expenditures).

This confidence allowed management to allocate up to $1.5 billion into a share buyback program for the quarter, taking as many as 62 million shares off the market. Knowing what lies ahead for PayPal stock, management expressed in its guidance that it will match the $5 billion in expected free cash flow to the buyback program.

Over the past 12 months, management has allocated up to $5.1 billion into share buybacks, taking out as much as 5% of the outstanding existing shares. Adding the $5 billion for the end of 2024 would equate to 10% of shares being taken out and roughly 16.4% of the company’s market capitalization.

For investors questioning whether the stock is undervalued, management's decision to allocate $10.1 billion over 24 months for stock buybacks suggests they see it as attractively priced, not overvalued.

But they aren’t the only ones in the market who believe this. Wall Street analysts align with management’s EPS growth forecast, as today’s consensus projection is 9.9% growth for the next 12 months. This acceptance helped Monness Crespi Hardt slap a valuation of $88 a share on PayPal stock, daring it to rally by 49.4% from where it trades today.

While this price target may seem bold, it aligns with the $90 share price target Mizuho Financial Group analysts placed nearly three months ago. As optimistic as this may seem, traders are also accepting PayPal stock’s fate.

Short interest declined by 4.8% over the past month for PayPal, a signal of capitulation from bearish traders now realizing that all drivers showcased growth within the company.

More than that, now that the Federal Reserve promises to cut interest rates by the end of 2024, the financial sector will potentially outperform. The leading Financial Select Sector SPDR Fund (NYSEARCA: XLF) will lead the way, and PayPal’s competitors, Mastercard Inc. (NYSE: MA) or Visa Inc. (NYSE: V), will match the momentum.

Source MarketBeat