The beaten-down stocks of high-quality, high-margin, high-cash-flow companies can rebound sharply if there's even a small change in investor sentiment...
As I discussed in yesterday's e-mail, software companies Intuit (INTU), ServiceNow (NOW), and Salesforce (CRM) are good examples of this phenomenon.
Today, let's look at another candidate that meets this description: payment company PayPal (PYPL).
First off, its stock chart is ugly...
After PayPal spun off from eBay (EBAY) in 2015, the stock skyrocketed nearly 10-fold for six years. It then crashed over the past five years and is now almost back to its price from 11 years ago:
Despite the stock's trajectory, PayPal certainly qualifies as a high-quality business. We can see this by analyzing its financials...
While its gross margins have declined over time, they've stabilized in recent years. And its operating margin has risen, reaching a healthy 18.2% in the latest quarter:
PayPal has also grown both its revenues and operating income at a high and steady rate over an extended period:
The business has very low capital expenditures ("capex") and generates lots of free cash flow ("FCF"):
As for how it allocates this FCF, PayPal made a number of acquisitions in its early years and pays a small 1.3% dividend today. But mainly, it has become a share-repurchase machine in recent years:
In fact, share repurchases have outpaced FCF. The company has gone from having $7.1 billion of net cash in 2018 to $2.3 billion of net debt today – a tiny amount equal to less than five months' worth of FCF:
These share repurchases have reduced its diluted share count by 20% in the past four years (which, mathematically, increases earnings per share by 25%):
In summary, PayPal has exceptionally strong historical financials: high margins, growth, and FCF, a strong balance sheet, and smart capital allocation.
Despite this, the stock has been obliterated. At yesterday's closing price of $44.53, it trades at a mere 8.4 times this year's consensus earnings estimates of $5.30 per share.
That's a small fraction of the S&P 500 Index's multiple of 22 times. And it's within a whisker of PayPal's all-time low, as you can see in this long-term chart of forward price to earnings (P/E):
This is a low multiple for such a high-quality business, which has caught the eye of many smart investors.
I'll share the bull cases from two of them in tomorrow's e-mail, so stay tuned!
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.
P.P.S. My parents and I spent the past two days at their beach house in Lamu, Kenya, which they just sold. After 20 years of wonderful memories, we said goodbye to it for the last time today and flew back to Nairobi. Here are some pictures:
