Key insights
- Paypal's stock declined significantly after Q1 earnings due to weak Q2 EPS guidance, raising concerns about margin compression despite substantial buybacks. At a price of $45, the market is pricing in a perpetual 4-5% decline in free cash flow, implying extreme pessimism. The author suggests that even with flat FCF, the stock is undervalued, presenting potential upside if the company avoids permanent decay.
I looked at PayPal’s Q1 numbers today. The stock obviously got hammered, mainly because Q2 EPS was guided down ~9%. That basically broke the bull thesis that their massive $6B/year buybacks could cover up the ongoing margin compression.
But what surprised me tbh was looking at what the stock is actually pricing in right now at ~$45.
They guided for $6B in free cash flow this year. At today’s price, the market cap is around $41B. That’s almost a 15% FCF yield.
If you reverse engineer that using a basic Gordon Growth Model ($41B = $6B / (10% - g)), the market is implying a growth rate of -4.6%.
So at a standard 10% discount rate, the market is pricing in a business whose free cash flow declines by about 4-5% every single year, forever.
That’s wild. Braintree is diluting their transaction margins and they have real issues to fix. But this is still a company processing nearly half a trillion dollars a quarter. It’s the default checkout button everywhere.
Even if they literally never grow again and FCF just stays flat at $6B forever, the math says the stock should be worth around $60B (about 45% upside from here). The current price isn’t just pricing in “margins under pressure for a while,” it’s pricing in permanent decay. Or put another way, if the earning power declines slower than 4% until all capitals are exhausted, the investment will likely make money.
My full notes is here if you are interested in more detailed numbers.