It was not so easy to identify my largest holdings, as I am invested in a number of companies that own almost or exactly the same number of shares. In the end, I chose PayPal instead of Alphabet, Japan Tobacco, The Bank of New York Mellon or Canadian National Railway. These are all interesting and profitable companies, but I wanted to place a focus on PayPal for this article and explain why it is one of the largest holdings in my portfolio.
PayPal - My largest stock holding and why it is so.
An explanation on what PayPal does is most likely not necessary; most of us are familiar with the concept. But from experience, I know too well that it is advisable to go into more detail about the company. I can then move on to explaining why PayPal is one of the largest positions in my portfolio.
Brief description of the PayPal business model
Before I go into the business model, i.e. how PayPal makes its money in the first place, let's take a quick look back at the story.
PayPal was originally founded by Max Levchin, Peter Thiel and Luke Nosek in December 1998 as Confinity, a company that developed security software for handheld devices (small computers you could hold in your hand; sounds like a precursor to the smartphone). However, the three did not succeed with this business model, so they shifted their focus to a digital wallet. The first version of this electronic payment system called PayPal was launched in 1999.
In March 2000, Confinity merged with x.com, an online financial services company founded in March 1999 by Elon Musk, Harris Fricker, Christopher Payne and Ed Ho. Musk was optimistic about the future success of the money transfer business developed by Confinity. There were disagreements between Musk and Bill Harris, the then president and CEO of X.com, about the possible future success of the money transfer business, and Harris subsequently left the company in May 2000. In October of that year, Musk decided that X.com would abandon its other internet banking businesses and focus on PayPal. That same month, Elon Musk was replaced by Peter Thiel as CEO of X.com, which was renamed PayPal in 2001 and went public in 2002. PayPal went public under the symbol PYPL at a price of $13 per share and raised over $61 million.
Ebay acquired PayPal almost immediately after the IPO and incorporated it into the company. At the end of September 2014, at the urging of the famous investor Carl Icahn, PayPal was taken public through a spin-off. After PayPal became an independent listed company again, it was able to develop very well. Especially the e-commerce sector that brought PayPal a lot of money.
Since we have just arrived at the point of money, let's now take a closer look at PayPal's business model.
How PayPal earns its money
PayPal earns its money primarily by processing customer transactions as a payment platform and with other value-added services. The income streams are therefore divided into transaction revenue based on activity volume or total payment volume. And additionally, into value-added services, such as interest and fees from loans and interest income. In 2021, PayPal processed a total of $1.25 trillion in transactions, with a net revenue of $25.4 billion and an operating income of $4.3 billion.
Short stock analysis on PayPal
Of course, the inner values of a company should not be missed and by that I mean, what about PayPal's financial stability and key figures?
The following chart reflects the key figures of the income statements of the last years.
What is particularly observable here is that profit has developed positively in parallel with revenue growth. This indicates that PayPal has been able to grow continuously in a healthy way, even if costs have increased as a result. Above all, it should be emphasized that the net margin has averaged 15% in recent years and can be expected to maintain this level. Especially as more and more payment transactions are made via the internet in general, in particular via mobile devices.
Furthermore, PayPal has a solid balance sheet for a fintech and can fall back on an equity ratio of approx. 29%. Due to the steady growth in profits, the company has been able to consistently improve its profitability.
In the case of cash flow, capital expenditure (CapEx) comes to mind, as does free cash flow. As a rule, a company with a sustainable competitive advantage uses a smaller portion of its profit for capital expenditures that serve current business operations than companies without a sustainable competitive advantage. Free cash flow is an indicator of the company's ability to generate cash over a period of time. Warren Buffett likes to say that it is the money that an owner could take out of his business and spend for his own benefit. Free cash flow is an important ratio because it takes into account the ongoing capital expenditures needed to maintain a healthy business. This is not the case with profit and even operating cash flow.
Due to the Ukraine war, rising inflation, and fears of a recession, PayPal shares have fallen very sharply, even though the company is in a better financial position than ever before. Furthermore, the euphoria on tech stocks since the end of many Corona lockdowns in Europe and North America is also no longer in strong demand.
I personally find the WallStreetZen fair value valuation is fair in the current situation of the financial markets, considering the war-related political mess and energy supply situation. People will probably consume less if heating costs explode in winter. In the long term of 10 or 15 years, I can well imagine a valuation at 175 US dollars to 225 US dollars.
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How PayPal became one of my largest stock positions
Enough talk about PayPal as a business model and the financials. Let's move on to why it matters so much to me and how PayPal became one of my largest stock positions.
Actually, I always wanted to invest in PayPal. It has probably been on my watchlist for 10 years, but somehow, we didn't really fit together. The stock was just always too expensive for me and I don't like paying too much, even if it is a strong company.
But in May 2022, the time came and I bought into PayPal. But this was not the only time I invested into PayPal shares. I bought them in several intervals.
Why did I buy PayPal shares so quickly? Well, the time was right. With the turmoil in the markets, it was my chance to finally strike. And as mentioned earlier, I had always wanted to own PayPal shares. As a result, the company quickly became one of my largest stock positions, along with Japan Tobacco, Alphabet and Canadian National Railway.
Why did I invest in PayPal?
This is the most important question of all to ask yourself as an investor. Why should I invest in PayPal, or in my case, why did I invest in PayPal. And that is exactly why I would like to go into this question in more detail here.
As already mentioned, I have been involved with PayPal for years, but that was not the only reason. What speaks for the company is that it fits into my Circle of Competence. I worked in the financial sector before becoming an entrepreneur and know how financial institutions work. Furthermore, I am passionate about digital business models, as I own some myself, it is easy for me to understand them. It is a well-run company that has a competitive advantage in its market. That's why PayPal fits well into my portfolio.
I also see PayPal well positioned for current events. There could be short-term downturns in users, but consumer behaviour should change by Christmas at the latest, of course if there is no energy crisis. But this would prompt me to buy even more shares in PayPal and thus, expand my position.