Do you think you can invest like Warren Buffet? Today, I will try me luck. I will evaluate PayPal to see if it passes my ‘Warren Buffett checklist.’
Note: While based on real-world data from April 2024, this content is for educational purposes.
Why I am evaluating PayPal:
PayPal is currently a trending stock with lots of news coming out about it. With all this hype, I was curious about its actual fundamentals and wanted to evaluate it myself. As an account holder with both Venmo and PayPal, I also thought it would be fun to see the business model surrounding my usage.
To clear the air:
For those who are new to my content, the ‘Warren Buffett checklist’ is not a literal checklist that Buffett directly advocates for in any way. I want to make this clear. However, it is a checklist that I made based on a list of hypothetical questions Buffett would likely ask, including his 4 main investing rules, key fundamental metrics, and value investment thinking. This is not advice on WHAT to invest in, but HOW you should go about thinking about investing. Do not buy a stock just because it passes the checklist.
Where I am getting the initial data:
To get recent stock data, I am using Yahoo’s stock lookup tool. I use this lookup tool to grab PayPal’s financial data.
Does PayPal pass rule #1?
Rule #1: A stock must be managed by vigilant leaders.
Debt-to-equity
Warren Buffett and other value investors like myself like investing in companies with good debt control. Buffett prefers a debt-to-equity ratio of under 50% or .5. Let’s see how PayPal is doing.
Currently, PayPal’s debt-to-equity ratio is .56. This means the company uses 56% of its debt to finance its assets. PayPal does not pass the debt-to-equity ratio test. However, 6% off is getting pretty close! We will have to see how they manage this debt in their cash flow statement.
PayPal does not pass, but the company was pretty close!
Current-ratio
Another metric to look at is a company’s current ratio. The current ratio evaluates the same debt and assets, except only for the short term. Current = short-term. Buffett prefers a current ratio of over 1.5. In the short term, we want at least $15 coming in for every $10 going out of the business. This ensures the longevity of the company and keeps the business away from bankruptcy. Let’s see how PayPal is holding up!
PayPal has a current ratio of 1.27. This is .23 short of what a good value investor would prefer, and means PayPal does not pass the current ratio test. They have about $13 coming in for every $10 going out of the business.
PayPal does not pass, but the company was pretty close!
Does PayPal stock pass rule #2?
Rule #2: A stock must have long-term prospects.
Do I think PayPal will be here for 50+ years?
Don’t get me wrong—I think PayPal is a fantastic company. While this could be out of clear ignorance, I don’t necessarily understand how they make money outside of transaction fees. But, with 400 million+ users and growing, that transaction fee pie can be massive.
PayPal’s mission statement from their most recent 10-Q is this: “PayPal’s mission is to revolutionize commerce globally by creating innovative experiences that are designed to make moving money, selling, and shopping simple, personalized, and secure.” Regarding competition, its companies are largely the only names I can think of when paying someone online. I mean, ‘Venmo’ is a literal verb. Stripe and some other SaaS payment providers are the only notable ones I can think of as main competitors. These competitors primarily focus on general payment sharing and simple e-commerce transactions.
That said, I still think there is much innovation and growth in internet commerce. Think cryptocurrencies, blockchain, Apple one-tap credit cards, and Shopify one-link. Who knows if Amazon or Walmart will design their payment platforms?
While it might be a wild ride and require lots of innovation, I still believe that PayPal will be one of the top payment processors in 50 years. While other payment processors will likely come out trying to steal away its market share, that is all healthy in a competitive environment. One thing is certain now: you can purchase with PayPal on any site these days. I expect this not to change anytime soon for convenience’s sake.
PayPal does pass with skepticism.
Will I hold PayPal for over 1 year?
This test is more of a reality check for your reasoning behind buying the stock. In other words, are you looking for a short-term gain or a long-term investment? Buffett advocates for buying and hopefully never selling.
If I bought PayPal, I am not sure I would want to ride the wild ride for over 50 years. Even in the next year, I expect it to be highly volatile and unpredictable.
Personally, PayPal does not pass the test for me. Its lack of stability (in terms of how it is currently being traded, not necessarily the fundamentals) makes it difficult for me to remove emotions from the equation.
I do not pass.
Does PayPal pass rule #3?
Rule #3: A stock must be stable and understandable.
Am I an expert in this industry and/or industry is very easy to understand?
I am not an expert in the payment processing industry. Understanding competitive advantage in this industry is difficult because I don’t know how people will be paying in 20 years. Think about how much has changed since 2000. I would need to research why PayPal would be a clear winner in this industry.
I do not pass.
Is the equity (book value) per share stable over last 10 years?
Book value is another word for equity/assets. It is what the company has as both current and long-term assets on the balance sheet. We are looking at this on a per-share basis. A good value investor like Warren Buffett would want to see a very stable, predictable upward trend.
PayPal seems to have experienced some high growth in its early stages but continues to experience periods of plateauing and growth. However, over its 10-year life, I would not consider this book value to be unstable.
Some things to look into are why PayPal’s book value decreased in 2022 and 2018. Did PayPal pay off some debts, did revenue decrease, or was there a mystery behind it?
From a quick glance, PayPal appears to have decreased some of its debt. This is a good thing! The company is using cash or revenue to reduce some of its debt, which may account for some of the book value decreases.
PayPal does pass.
Is the debt-to-equity ratio stable over the last 10 years?
What we want to see here is a stable chart with no big spikes. Big spikes equal more risk. Risk can be good if the company knows what it is doing. However, investors like Warren Buffett would prefer to stick with stable companies that do not need to borrow significant sums of money. I like to lean in a similar direction.
It looks like PayPal has increased its debt pretty substantially over the last 10 years. However, the company’s assets in 2023 were still double its debt. This is what you want to see for a healthy company!
I would suspect they are just taking on debt to fuel faster growth. What we do not want to see is this ratio start moving beyond .5. While many companies are fine while doing this, they are just playing with more risk than my taste.
For more research, I would look into what they are using the debt to invest in. Let’s hope for something worthwhile!
PayPal does pass.
Is the earnings per share stable over last 10 years?
For this part of the checklist, we are looking for EPS that has remained stable and not moved in drastic directions over the last 10 years. The goal is to predict potential EPS growth for the next 10 years easily.
PayPal passes with heavy green colors. It looks like they had heavy growth during the COVID-19 era (which makes sense with more online e-commerce transactions). Then, post-COVID, the company had a bit of a dip. Overall, over the last 10 years, PayPal’s EPS has stayed on a similar trend, receiving incremental growth year over year. The site has marked about 17.68% growth for each year since 2014.
The company is certainly a growth technology stock. I would note that companies never receive hockey stick growth forever, so that is something to keep in mind when looking at growth stocks. The 18% EPS growth could turn to 6% EPS growth once it matures more in 20 years. More research could be done to understand how PayPal might sustain this level of growth far into the long term future.
PayPal does pass.
Another noteworthy find about PayPal (not necessarily part of an ordinary analysis).
PayPal has been buying back many shares outstanding in recent years. Reducing shares outstanding can artificially increase earnings per share. I personally would prefer dividends, but it is one way a company can increase the value of shareholders staying for the long term.
This is not necessarily a good or bad sign, but it is something to keep in mind when looking at the above charts.
PayPal’s financial staff is telling the market, “We think our stock is cheap right now, so we will buy it with our own cash.
Where I got the above data:
To get recent historical data for long-time periods, I am using Gurufocus PayPal 30-YR financial data, looking at 15-year trends. For 10 year trends, I am looking at stockanalysis.com’s PayPal 10-year balance sheet.
Does PayPal stock value pass rule #4?
Rule #4: A stock must be undervalued. (Charlie Munger says great business at a fair price.)
Is (Price / Earning per share) * (Price / Book Value) < 22.5 ?
We are using Graham’s ratio to evaluate if PayPal is undervalued or overvalued by its current price. It is based on the assumption that we do not want a price-to-earnings ratio of no more than 15x and a price-to-book ratio of no more than 1.5x. Both of this ratio multiply out to be 22.5, so we want to be under both of these when we multiply the ratios!
PayPal’s current PE ratio is 16.11.
PayPal’s current PB ratio is 3.23.
This means PayPal is 16.11 * 3.23 = 52.03. 52.03 is not less than 22.5
PayPal does not pass this test. However, it is important to know why rather than simply disregarding the stock. The company has a solid PE ratio of 16.11 (close to the 15 that Graham likes). However, its price to book value ratio is almost double what we seek. One reason may be that a technology stock like PayPal may have less book value than a company with big factories and large assets.
PayPal’s property, planet, and equipment account for only 2% of the company’s total book value.
While the company does not pass this test, it is important to note that the checklist aims to push us to look in the right places. The checklist is not the be-all and end-all answer to whether you should invest in the company. The numbers paint a picture of the business, but the numbers are not the business.
PayPal does not pass.
For many years into the future, how does PayPal compare to a 10-yr treasury bond?
Something highly discussed in the investment community is how to calculate the intrinsic value of companies. Unfortunately, there is no exact formula to predict the future value of a company. Estimating is more of an art than a science. Buffett laid out his understanding using Aesop’s tale:
The oracle was Aesop and his enduring, though somewhat incomplete, investment insight was “a bird in the hand is worth two in the bush.” To flesh out this principle, you must answer only three questions. How certain are you that there are indeed birds in the bush? When will they emerge and how many will there be? What is the risk-free interest rate (which we consider to be the yield on long-term U.S. bonds)? If you can answer these three questions, you will know the maximum value of the bush and the maximum number of the birds you now possess that should be offered for it. And, of course, don’t literally think birds. Think dollars.”
Buffett in 2000, predicting the dot-com bubble. ‘Beware of bird-less bushes.’
At the end of the day, to understand a company’s value, we look at three main things: how much cashflow a business can generate over its life, how long the life of the company is, and our certainty of both of these items.
To accomplish this, we can treat PayPal’s stock just like we would treat it with a bond perpetuity. This considers PayPal stock if it continues to produce similar cash flow forever.
As Buffett says, “the value of American business depeonds on how much it delivers in cash to its owners between now and judgment day.”
What we are looking for is for the stock’s intrinsic value to be misrepresented in its current market price.
Not accounting for growth in cash flow
Present value = Cash flow / interest or discount rate.
The current 10-yr treasury bond is 4.5%. PayPal’s current operating cash flow is $4.843 billion.
PayPal’s present value = $4.845 billion / 4.5%
Without account for growth, PayPal’s intrinsic value would be $107.6 billion when compared to the 10-yr treasury bond at 4.5% annual discount.
Many investors prefer to look at free cash flow, which is the same thing expected without capital expenditures.
The company’s current free cash flow is $4.265 billion.
PayPal’s present value = $4.265 billion / 4.5%
Using this instead, the company’s intrinsic value would be around $94.8 billion, compared to the 10-year treasury bond at 4.5% annual discount.
The company’s current market capitalization is $67.55 billion.
Accounting for growth in cash flow
To account for high growth, I like to use this DCF online calculator. It also accounts for cash flow in perpetuity (what we did earlier). To start, I put the free cash flow at a 5% conservative growth annually for the next 10 years. I am trying to be as conservative as possible to see if there is a deal in the stock. PayPal has done an average 10% free cash flow growth over the last years. So, a good 50% margin of error is on the less risky side for the next 10 years.
I used 4.5% as the discount rate and did a 1% growth in perpetuity after the 10-year growth period. This creates a 3.5% discount in perpetuity each year,
I also moved the valuation to per share by dividing the total market cap and intrinsic value by the total outstanding shares.
The calculator states, “Based on the cash flows you[I] have forecasted and a market price of $64.58, this company may yield a 9.3% annual return.” “The intrinsic value per share is $165.24 at a 4.5% annual discount rate.”
The intrinsic value is higher than the current market price, so PayPal passes. However…
Remember: All of these numbers and percentages can be changed to tell a different story. These calculations also all rely on the fact that we believe PayPal will be around forever. The company passed that test with high skepticism,
PayPal does pass, but this is with the numbers I inputted and ballparked.
In closing…
PayPal is most likely not a stock pick on Warren Buffett’s list due to much uncertainty about the software’s future in the competitive market place of payment processing. Further, its high-growth nature makes it very difficult to estimate its valuation. I will be the first to say that our valuation sections were guestimations at the very best. That being said, PayPal is doing a lot of the right things to run a fantastic company- decreasing debt, increasing book value, and maintaining decent debt to equity.
While we got a quick glance of the company, there are many more things to look at in this company, including:
- What is the current management and management history?
- What does the competition in the payment transaction marketplace?
- Long-term competitive advantage, if any?
- What is the peak growth that PayPal could reach?
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Disclaimer: This is Not Investment Advice
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