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Wednesday, September 28, 2022

Don’t Be Fooled by the ‘Bull Case’ for PayPal Stock

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Bullish analyst ratings and activist involvement have helped to shift sentiment for PayPal (NASDAQ:PYPL), resulting in a rebound for PYPL stock since July. After falling to as low as $67.60 per share, it’s climbed back up to the mid-$90s per share. That’s around a 36% increase in fewer than three months.

With this bounceback, should one assume more gains lie ahead for shares in this payments-focused fintech firm. In fact, following its large move higher in recent months, the stock may be just about to give back some of these recent gains.

With its cost-cutting initiative and share buyback plans, there’s a lot in play that could in theory boost its value. However, one can argue that these positives are already factored into its valuation. Not only that, the market right now may not be factoring in the impact of a recession on future results.

PYPL Stock and Limited Runway

Analysts have become bullish again for PayPal shares for one reason: the prospect of higher earnings per share (or EPS) through cost-cutting and share repurchases. Per their view, this will help justify an additional move higher for the stock. In essence, they are taking the argument that PYPL stock will move up, in tandem with improvements to EPS.

However, I see it the opposite way. In anticipation of higher earnings, the stock has already moved higher. Trading for 23.3x forward earnings, the market has already priced in the company’s ability to improve its operating performance, even as it reports lackluster revenue growth.

Until it begins to see its top-line growth re-accelerate, it will be difficult for shares to justify a much higher valuation. Hence, after its partial recovery, it has limited runway, at least in the near term.

Worse yet, rather than hold steady at current levels, there’s a good chance it moves lower in the near term. The macro challenges that have played a big role in its poor performance since last year are still in play. As I hinted at above, it could see its operating performance further affected by changing economic conditions.

What Could Counter Cost-Cutting Benefits

There’s another reason why cost-cutting isn’t the panacea for PYPL stock many expect it to be. A recession could counter cost-cutting benefits. It’s unclear to what extent an economic downturn could affect its operating performance.

On one hand, areas like e-commerce payments would be affected. A recession will worsen the e-commerce space’s post-pandemic hangover. On the other hand, segments like peer-to-peer payments platform Venmo may see only minimal impact. An app that enables friends and family to split payments may come in handy during a time of belt-tightening.

Still, I wouldn’t just assume PayPal’s results will hold steady in a downturn. If a recession happens, chances are the company will see some sort of negative impact from it. This would eat into the earnings boost from the above-mentioned cost savings.

In other words, instead of handily beating Wall Street forecasts, it could come up short. The prospect of a lower-than-expected boost from cost-cutting would put more pressure on the stock. It may not necessarily send it to a new 52-week low. It could, perhaps, result in shares moving back to price levels last seen before the analyst/activist boost (mid-$70s per share).

Bottom Line on PYPL Stock

The bull case for PayPal may seem like a slam dunk on paper, yet it’s erroneous to assume it will play out seamlessly. Depending on how things shape up on the macro level in the coming months, the benefits from cost reduction, as well as financial engineering efforts like buybacks, could be blunted by declines in its profitability caused by a recession.

Even if it sees only a minimal impact from a recession, this may not be enough to boost its valuation further. Until there’s a definitive plan in place to re-accelerate its revenue growth, it’s going to be difficult for shares to command a higher valuation than what they currently trade for today.

Put simply, PYPL stock right now is a situation with limited upside, coupled with a potential near-term downside. Until the proposition changes, continue to avoid it.

PYPL stock earns an F rating in my Portfolio Grader.

On the date of publication, neither Louis Navellier nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.

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