The rise in online shopping over the past decade has led to a surge in digital payments. And consumers increasingly want convenience, speed, and safety when it comes to their checkout options. The pandemic only accelerated this behavior.
How does PayPal make money?
PayPal's business model is pretty simple: The company collects a transaction fee on the payments that move on its network. For the trailing-12-month period, total payment volume (TPV) of $1.1 trillion generated revenue of $23.8 billion. This means that PayPal's take rate (revenue divided by payment volume) was 2.1% during that time. Management's primary objective, unsurprisingly, is to grow the number and dollar amount of transactions that the business processes. Net income and free cash flow (FCF) generation will follow.
For individuals, the company offers services like Venmo, its popular peer-to-peer platform that also lets users buy cryptocurrencies. And the flagship PayPal mobile app, which recently got a huge upgrade, includes features like buy now, pay later (BNPL), bill pay, early direct deposit, shopping deals, and access to a high-yield savings account.
PayPal lets merchants accept digital and mobile payments with Braintree, and iZettle offers a card-acceptance and software solution to record, manage, and analyze sales. These business customers can also turn to PayPal to receive working capital loans to help with day-to-day operations.
PayPal's proven ability to offer a complete financial services suite for both consumers and businesses, while posting stellar quarterly financial metrics like an 18.1% operating margin and a 17.6% FCF margin, are why the stock has crushed the S&P 500 since it returned to the public markets in July 2015.
What are PayPal's competitive advantages?
As a two-sided platform with 371 million active consumer accounts and 32 million active merchant accounts, PayPal's biggest competitive advantage comes from having a network effect. If I run an e-commerce site, I want whichever payments service gives me access to the largest potential customer base. And if I'm an individual shopper, I'll only consider using an app that's widely accepted wherever I go. The value of the overall network clearly increases with additional users.
PayPal also possesses powerful intangible assets, or characteristics that are virtually impossible for rivals to copy. The PayPal brand is widely recognized as a safe and secure payment method in over 200 markets (and 25 currencies) globally. And since its founding more than 20 years ago, the company has developed expertise in digital payments as one of the pioneers in the space. Finally, because PayPal is so vital to the daily financial lives of its users, it has the rare ability to continue introducing new features in order to drive higher levels of engagement (and revenue) over time. This optionality is extremely valuable.
It's no wonder management raised full-year 2021 guidance across the board, expecting higher growth for TPV (33% to 35%), revenue (20%), and earnings (21%) compared to 2020. And Wall Street is optimistic as well, as the consensus rating on the stock is a strong buy with better than 35% upside over the next 12 months at recent prices.
Adding a stock like PayPal is a smart move for any investor.