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But don’t buy and hold until you know these three risks

Vaseline 2 months ago

The S&P500 And Nasdaq Composite have been impressively busy since the beginning of 2023. This bullish sentiment may make investors concerned that they will not be able to find attractive buying opportunities.

Still there Are still cheap companies to buy, I think PayPal (NASDAQ:PYPL) is one of them. The online payment service’s shares have plummeted in recent years and were recently nearly 80% below their peak price. But the stock now trades at a favorable price-to-earnings (P/E) ratio of 12.3.

Don’t rush to buy and hold PayPal just yet. Here are three risks to consider with this digital payments pioneer.

1. Intense competition

The broad, secular growth story of cashless transactions, coupled with how lucrative these businesses can be at scale, has attracted a lot of competition to this space. PayPal deserves credit for being the first pure online payments provider, developing a strong brand known for trust and security. But it’s getting busier.

Braintree is PayPal’s merchant-focused solution. Growth has been spectacular recently, with payment volume increasing by 30% by 2023. However, it takes on heavyweights like Stripe, AdyenWereldpay, and Fiserv‘s first data, to name just a few. Competing on price, ease of use and product features is what Braintree is trying to do, but it will have to be at the top of its game if it wants to grow market share.

It’s the same story on the consumer side. PayPal’s digital wallet is widely accepted, but there are numerous other players catering to individuals and their needs.

Apple Pay, and to a lesser extent, AlphabetGoogle Pay, are digital wallet providers that should keep PayPal management awake at night. Because these dominant tech companies control the two most popular mobile operating systems, they can put their payment services ahead of PayPal’s.

PayPal’s user base at the end of 2023 – 426 million active accounts – fell 2% year over year. If the company can’t keep the competition at bay, this key metric will continue to trend in the wrong direction.

2. Capital allocation

Dan Schulman, the company’s former CEO, may have wasted capital on wasteful acquisitions that were not necessarily core to PayPal’s business. The company paid $4 billion for Honey and $2.7 billion for Paidy, to name its two largest purchases. Schulman was also focused on building a super app that could rival those in China, a strategy he did not follow.

The previous leadership may have made poor capital allocation decisions. There is always a risk that the new CEO, Alex Chriss, will also follow this path. I understand that he is focused on product innovation, especially with the advent of artificial intelligence. He is trying to find ways to integrate this technology into PayPal’s various offerings.

But if I were running the company, it would be difficult for anyone to stop me from wanting to use all the money produced and available to buy back shares. To be fair, PayPal spent all of its free cash flow on buybacks last year, with the intention of doing the same this year.

The company currently has a net cash position of $6 billion. It might be smart to use some (or all) of this to buy back even more shares, especially when the stock is trading at a dirt-cheap valuation.

3. The Venmo problem

In 2023, Venmo represented 18% of PayPal’s total payment volume. It’s a sizeable business, but investors worry that generating revenue has been a challenge. I suspect that the vast majority of Venmo use, i.e. people sending money to each other, does not generate any revenue for PayPal.

Venmo’s biggest competitor, Block‘s Cash App has arguably been much more successful at monetizing its user base. Cash App has 56 million monthly active customers and generated $4.3 billion from them gross profit in 2023. That’s because it appeals to lower-end consumers who view it as a sofa replacement.

A valid argument can also be made that PayPal can find a way to merge the PayPal and Venmo apps into one consumer-facing app. They have many of the same features anyway.

Now that you understand what I believe are three major risk factors, you can make a more informed decision about the stock.

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Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Neil Patel and his clients have no positions in the stocks mentioned. The Motley Fool holds positions in and recommends Adyen, Alphabet, Apple, Block, and PayPal. The Motley Fool recommends the following options: June 2024 short calls of $67.50 on PayPal. The Motley Fool has a disclosure policy.

1 Undervalued Growth Stocks Are Down 79%: But Don’t Buy and Hold Until You Know These 3 Risks. originally published by The Motley Fool