From losing accounts to surging profits, PayPal's total disbursements soared 11%! How can investors seize this wave of markets?

PayPal Holdings, Inc. (NASDAQ: PYPL)'s second-quarter results showed that the fintech company made some progress in reducing account losses.

PayPal has achieved double-digit growth in total payments, an important indicator, and expects to increase free cash flow and share buybacks by 1 billion dollars in 2024. The fintech company also maintained a high operating margin of over 18% and expects profits to grow further after the release of the second quarter results.

Although I still have some concerns about PayPal's account issues, increased share buybacks, free cash flow, and profit expectations are the reason I upgraded their stock rating to “buy.”

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PayPal had previously anticipated steady profit growth in 2024, but the uncertainty of losing accounts kept me cautious.

Previously, I rated PayPal stock as holding, but now I'm upgrading my rating to “buy” because the outlook for profit, free cash flow, and share buybacks is more optimistic.

PayPal's higher free cash flow will enable it to buy back more shares, and these repurchases are expected to take place at a lower price-earnings ratio.

In the second quarter of 2024, the total number of PayPal platform customers was 0.429 billion, an increase of 2 million over the previous quarter, but the total number of accounts was still lower than the 0.431 billion users who traded on the PayPal platform in the same period last year.

In my opinion, PayPal's inability to effectively increase the number of customers was the main reason why PayPal's stock price fell far short of expectations last year.

Generally, PayPal's second-quarter earnings report performed well in other areas, but investors should not underestimate the severity of its account issues. If PayPal doesn't continue to grow users, I think it will be difficult for PayPal to increase its valuation in 2024.

On the other hand, despite poor account growth, PayPal's total payments increased 11% year over year. In the US and international markets, total payments increased by 11% and 10%, respectively. The increase in total payments led to an 8% year-over-year increase in PayPal's sales in the second quarter.

PayPal's second-quarter non-GAAP operating revenue was $1.4 billion, up 15% year over year, mainly due to increased number of transactions, increased total disbursements, and ongoing cost restructuring.

Although its operating margin did not increase in the second quarter, it remained at 18.2% (compared to 18.3% in the previous quarter). This was the second consecutive quarter that the non-GAAP operating revenue margin was over 18%.

Given the growth in total payments and ongoing cost reductions, I think there is room for PayPal to increase profit margins in terms of operating expenses.

While PayPal has issues with continuing to grow the number of accounts, this hasn't stopped the fintech from raising its 2024 profit forecast. The company now expects GAAP earnings per share in 2024 to be between $3.88 and $3.98, higher than the previous forecast of $3.65.

In 2023, PayPal earned $3.84 per share, so the company now expects at least some profit growth this year (earnings were previously flat).

Note that PayPal not only raised profit expectations, but also raised free cash flow and share buyback forecasts: the company raised its free cash flow forecast by $1 billion to $6 billion. This also means that the company expects to use 100% of the year's free cash flow for share buybacks.

PayPal's profit forecast (median of $3.93 per share) means a price-earnings ratio of 15.0 times, while based on next year's earnings, the company's forward-looking price-earnings ratio is 12.8 times.

PayPal's profit is expected to increase 10% year over year, which may be conservative if the company can keep TPV growth steady and focus on cutting costs.

SoFi Technologies, Inc. (SOFI) has a forward-looking price-earnings ratio of 30.7 times, but the company is growing faster and accounts are growing strongly, which is the challenge PayPal is facing. Block Inc. (SQ) is probably PayPal's closest fintech competitor, with a forecasted price-earnings ratio of 14.0x.

If PayPal can manage its account issues and resume steady growth while maintaining an 18% non-GAAP operating margin and cutting costs, I expect its stock valuation to rise.

My estimated intrinsic value is $70. This is based on a profit multiplier of 15 times (and $4.68 forward-looking earnings per share), which I think is a reasonable estimate. This is mainly because the company is quite profitable in terms of free cash flow, and its cost cuts are beginning to have a positive impact on profits.

For obvious reasons, PayPal hasn't been able to consistently reverse the trend in its accounts, which clearly poses a challenge to its stock.

The increase in total payments volume and key metrics (profit, free cash flow, and share repurchases) was a positive result of PayPal's second quarter, outpacing ongoing account issues.

However, if PayPal loses more accounts and fintech market share again in the future, then even if profit margins, free cash flow, and profits grow, it may not be able to stop the valuation from falling.

Due to total payments and strong profit margins, PayPal surpassed second-quarter expectations and raised its 2024 profit, free cash flow, and share buyback forecasts.

It remains to be seen if PayPal can recover from the loss of customers that have seriously affected its performance over the past few quarters. Total payout volume growth reached double digits, supported by increased trading in the US and international markets. I think the stock has a forward price-earnings ratio of 12.8 times and is still relatively cheap.

I am now more confident that PayPal can maintain a non-GAAP operating margin of more than 18%. As the company prepares to buy more shares at low profit multiples, I think the risk/reward relationship has improved enough to be worth changing the stock rating to “buy.”