Shares of financial technology company PayPal (PYPL -5.21%) were up 39% in 2024, according to data provided by S&P Global Market Intelligence, compared to just a 23.3% return for the S&P 500.
It's been a while since this stock was a market-beater. The reality is that PayPal stock underperformed the S&P 500 for three straight years, as the table below shows. And at the end of 2023, the stock was back where it had traded in 2017.
| Year | 2020 | 2021 | 2022 | 2023 | 2024 |
|---|---|---|---|---|---|
| PayPal stock performance | 117% | (19%) | (62%) | (14%) | 39% |
| S&P 500 performance | 16% | 27% | (19%) | 24% | 23% |
Returns provided by data from YCharts. Table by author.
In 2024, PayPal benefited from rapid profit improvements. For perspective, the high watermark for the company's free cash flow came in 2021 with $5.4 billion. And in 2023, its free cash flow was just $4.2 billion. But in 2024, PayPal is forecasting free cash flow of $6 billion.
In short, PayPal's profits are trending toward all-time highs while its stock price was sitting at multi-year lows at the start of the year. That put PayPal stock in a good position to post its first market-beating year since 2020.
Why PayPal's profits are soaring
A few things are going on with PayPal's business. It's not necessarily impressing anyone with top-line growth -- through the first three quarters of 2024 its revenue was up less 8% from the same period of 2023. But its transaction margin is improving and its operating expenses are more under control.
A transaction margin is essentially what it costs PayPal to process a transaction compared to the revenue it generates -- similar to gross margin. In the first quarter of 2024, the company's transaction margin was 45%, followed by a 45.8% margin in the second quarter and a third-quarter transaction margin of 46.6%. This is the first time in a while that it's shown improvement here.
Moreover, key operating expenses for PayPal have come down as a percentage of revenue. In a nutshell, PayPal has higher revenue, better margins, and lower operating expenses, which all contribute to free cash flow potentially hitting its highest levels ever for the company.
What's next for PayPal's shareholders?
PayPal's Braintree business is an important component of its transaction margin growth. This is the company's unbranded checkout product and something that new CEO Alex Chriss has prioritized since joining the company in late 2023.
Therefore, much of PayPal's progress is due to a recent shift in priorities. It's consequently reasonable to believe this improvement has room to continue.
PayPal is using 100% of its free cash flow to repurchase shares. Lowering the share count is picking up momentum as well.
Data by YCharts.
PayPal stock is interesting here because it trades at a downright cheap valuation at 12 times its free cash flow. With a cheap valuation and a rapidly dropping share count, PayPal stock could have more upside in 2025.
