In his long history, Warren Buffett has produced multiple famous quotes. A lot of these quotes focus on value, including when (in his letter to shareholders in 2009) he famously stated that, “whether we’re talking about socks or stocks, I like buying merchandise when it is marked down”. I often follow this advice when I buy stocks, especially in the current climate, where many companies have suffered very large drops. PayPal (NYSE: PYPL) is one example that I feel is now far too cheap, and a good long-term buy.
Why has PayPal stock dropped?
PayPal has fallen nearly 70% over the past 12 months for several reasons. Firstly, there have been a couple of very disappointing trading updates, demonstrating poor growth. Most recently, this included weak forward guidance as revenues are ‘only’ expected to increase around 16%, against previous expectations of around 18%. Adjusted earnings per share are also expected to remain largely flat. Further, PayPal abandoned its medium-term goal of reaching 750m users. This poor forward guidance can be attributed to inflationary pressures and weakening e-commerce figures. There’s also increasing competition in the payments sector, including Apple and Google Pay.
The other reason for the recent drop is the weakness in all growth stocks now. Indeed, the high rate of inflation is particularly devastating for growth stocks, as these companies gain a large amount of their valuation from the value of future cash flows. High inflation also equates to higher interest rates, which increases the cost of borrowing. As PayPal has nearly $10bn in debt, this could increase costs further.
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Why do I think Warren Buffett would buy?
There are two main reasons that I think Warren Buffett would be tempted to buy PayPal stock.
Firstly, he’s a big fan of value stocks, and PayPal is trading at a very cheap valuation at the moment. For example, it has a price-to-earnings ratio of just under 20, which is historically low. Indeed, last year, the P/E ratio reached as high as over 70. PayPal is currently priced at similar levels to its price after the stock market crash in March 2020. Despite this, revenues and profits have grown considerably since this moment. This means the recent drop seems well overdone, and I feel a recovery could be under way.
PayPal is also a quality company, another factor I feel could tempt Warren Buffett to buy. For example, the company has an extremely healthy balance sheet, thanks to strong free cash flow generation. This has allowed the company to repurchase its own shares recently, so it has avoided share dilution. Due to the current low PayPal share price, I feel these share buybacks can be increased, which should help boost the shares.
PayPal is also exploring other avenues for growth, including a partnership between its subsidiary Venmo and Amazon. Hopefully, this can help restore PayPal to its prior strong growth.
Overall, I feel that these positives far outweigh the negatives, and this is why I may add more PayPal shares to my portfolio.
