Home Discount rate After weeks of selling, PayPal (NASDAQ: PYPL) is now in value territory

After weeks of selling, PayPal (NASDAQ: PYPL) is now in value territory


Despite strong third quarter results, PayPal Holdings, Inc. (NASDAQ: PYPL) took a double-digit plunge in the last trading session. It appears that the cautious forecast spooked the market, while other positive catalytic news failed to reverse the downward trend that has been going on for months.

As the stock has fallen over 30% from summer highs, in this article we will look at valuation under our model.

Check out our latest review for PayPal Holdings

Third quarter 2021 results:

  • Returned: US $ 6.18 billion (up 13% from Q3 2020)
  • Net revenue: US $ 1.09 billion (up 6.5% from Q3 2020)
  • Profit margin: 18% (compared to 19% in Q3 2020)

The company reported strong third quarter results with improved earnings and revenues, although profit margins were lower. Over the past 3 years, on average, earnings per share have increased by 35% per year, and the company’s stock price has also increased by 35% per year.

While PayPal has announced that it will not pursue the acquisition of Pinterest, its action has not recovered the ground lost in the initial rumor. It was one of the interesting ‘sell the rumor, sell the news’ moments.

Meanwhile, CFO John Rainey has advised caution regarding the start of next year, particularly with regard to the migration of eBay payments and the comparison to the start of this year, which was heavily influenced by government stimulus measures.

This has resulted in a series of price target adjustments, as Morgan Stanley now sees it at US $ 265 (revised from US $ 340), Oppenheimer at US $ 268 (from US $ 329) and Citi at US $ 300. (from US $ 350). Yet after acknowledging the headwinds – citing supply chain issues, the disappearance of stimulus measures and other aftershocks of the pandemic, they remain positive on the stock.

One of the main reasons for this may be a deal Venmo announced with Amazon. This popular mobile payment service owned by PayPal will be available as a payment option on Amazon.com in 2022.

Intrinsic value approach

The Discounted Cash Flow (DCF) model estimates that the value of a business is the present value of all the cash it will generate in the future. It works by taking forecasts of the company’s future cash flows and discounting them to today’s value.

However, a DCF is only one evaluation measure among many, and it is not without its flaws. For those passionate about equity analysis, the Simply Wall St analysis template here may be something of interest to you.

The calculation

We use the two-stage growth model, which means we take two stages of growing the business. During the initial period, the business can have a higher growth rate, and the second stage is usually assumed to have a stable growth rate. First, we need to estimate the cash flow of the business over the next ten years. Where possible, we use analyst estimates, but when these are not available, we extrapolate the previous Free Cash Flow (FCF) from the latest estimate or stated value.

We assume that companies with decreasing free cash flow will slow their rate of contraction, and companies with increasing free cash flow will see their growth rate slow during this period. We do this to reflect the fact that growth tends to slow down more in the early years than in subsequent years.

Usually we assume that a dollar today is worth more than a dollar in the future, and so the sum of these future cash flows is then discounted to today’s value:

10-year free cash flow (FCF) forecast

2022 2023 2024 2025 2026 2027 2028 2029 2030 2031
Leverage FCF ($, Millions) 7.47 billion US dollars US $ 9.25 billion US $ 10.9 billion US $ 12.6 billion US $ 13.8 billion US $ 14.8 billion US $ 15.7 billion US $ 16.4 billion US $ 17.0 billion US $ 17.6 billion
Source of estimated growth rate Analyst x13 Analyst x13 Analyst x3 Analyst x2 East @ 9.71% Est @ 7.38% Est @ 5.76% East @ 4.62% Est @ 3.82% East @ 3.26%
Present value (in millions of dollars) discounted at 6.5% US $ 7,000 $ 8.2,000 US $ 9.0,000 $ 9.8,000 US $ 10.1k US $ 10.1k US $ 10.1k $ 9.9,000 US $ 9.6,000 US $ 9.3k

(“East” = FCF growth rate estimated by Simply Wall St)
10-year present value of cash flows (PVCF) = US $ 93 billion

After calculating the present value of future cash flows over the initial 10 year period, we need to calculate the terminal value, which takes into account all future cash flows beyond the first step. For a number of reasons, a very conservative growth rate is used which cannot exceed that of a country’s GDP growth. In this case, we used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. Likewise, as with the 10-year “growth” period, we discount future cash flows to their present value, using a cost of equity of 6.5%.

Terminal value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US $ 18B × (1 + 2.0%) ÷ (6.5% – 2.0%) = US $ 391B

Present value of terminal value (PVTV)= TV / (1 + r)ten= US $ 391 billion ÷ (1 + 6.5%)ten= US $ 207 billion

The total value is the sum of the cash flows for the next ten years plus the present terminal value, which gives the total value of equity, which in this case is US $ 300 billion. To get the intrinsic value per share, we divide it by the total number of shares outstanding.

Compared to the current share price of US $ 205, the company seems on fair value with a 20% discount from where the stock price is currently trading. The assumptions in any calculation have a big impact on the valuation, so it’s best to take this as a rough estimate, not precise down to the last penny.

NasdaqGS: PYPL Discounted Cash Flow November 10, 2021

Important assumptions

Now, the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flow. Part of investing is coming up with your own assessment of a company’s future performance, so try the math yourself and check your own assumptions. DCF does not take into account the possible cyclicality of an industry or the future capital needs of a company, so it does not give a complete picture of its potential performance.

Because we view PayPal Holdings as potential shareholders, cost of equity is used as the discount rate rather than cost of capital (or weighted average cost of capital, WACC), which takes debt into account. We used 6.5% in this calculation, which is based on a leveraged beta of 1.047.

To move on :

Although important, the calculation of the DCF shouldn’t be the only metric you look at when looking for a business. Overall, it looks like our valuation is in line with some of the more conservative analyst price targets we’ve mentioned.

However, keep in mind that the DCF model is not a perfect stock valuation tool. Instead, the best use of a DCF model is to test certain assumptions and theories to see if they would lead to undervaluation or overvaluation of the company. If a business grows at a different rate, or if its cost of equity or risk-free rate changes sharply, output can be very different.

For PayPal Holdings, we have put together three essential aspects you should consider:

  1. Risks: To do this, you need to know the 2 warning signs we spotted with PayPal Holdings.
  2. Future benefits: How does PYPL’s growth rate compare to that of its peers and the broader market? Dig deeper into the analyst consensus count for years to come by interacting with our free analyst growth expectations chart.
  3. Other strong companies: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid trading fundamentals to see if there are other companies you might not have considered!

PS. The Simply Wall St app performs a daily discounted cash flow assessment for each NASDAQGS share. If you want to find the calculation for other stocks, search here.

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no positions in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents.

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