In the long-term investing world, one will often hear the phrase, "Watch the business, not the stock price." And one of the great things about the stock market is that publicly traded companies are required to disclose certain financial information. It makes watching the business very possible.
However, investors should be aware that any company could report good numbers in a given quarter. But it may just be a one-time anomaly. By contrast, it takes several quarters to establish a positive trend in a business. For this reason, investors need to be patient when watching the business, to ensure positive developments are truly underway.
For those watching the business with financial-technology (fintech) pioneer PayPal Holdings(NASDAQ: PYPL), its latest quarter indeed shows that a trend is developing and it's quite material to shareholders today.
A trend that's gaining momentum
PayPal stock is down roughly 75% from its all-time high in 2021. But here's a shocking statistic for those unaware: PayPal has never reported a year-over-year drop in revenue since going public in 2015. Its revenue growth has slowed, yes. But revenue has continued rising during its entire tenure as a publicly traded company.
That's an important trend but not the one that I want to call attention to -- I'll get there in a moment. But my point is that PayPal just keeps growing and that's good.
PayPal's problem is that, while it's revenue has climbed the same can't be said of its earnings. The chart below shows the company's revenue, gross profit, and free cash flow from the start of 2020 through the end of 2023. As can be seen, revenue kept climbing but gross profit and free cash flow began to decline.
PYPL Revenue (TTM) data by YCharts
Falling profit is a big reason the stock is down in recent years. But that's why the emerging business trend I'm about to highlight is important.
I included PayPal's gross profit above out of convenience. But in the fintech world, companies use a similar metric called transaction margin. PayPal reported financial results for its third quarter of 2024 on Oct. 29. And in Q3, its transaction margin hit 46.6%.
That transaction margin represents the second straight quarter of improvement for PayPal -- in other words, it's fair to call it the start of a trend. Moreover, 46.6% is the company's widest transaction margin since the first quarter of 2023.
Keep in mind that it's two quarters in a row for transaction margin improvement at PayPal. But the transaction margin dollars metric has improved for three straight quarters (think of it as the subtle difference between gross profit and gross margin).
After years of seeing revenue climb while profits went nowhere, PayPal may finally be on the cusp of unlocking better profitability.
Hoping for a PayPal turnaround?
There can be somewhat random catalysts to move stocks in the short term. But longer-term moves have more defined drivers. Revenue growth is quite important. But investors can't overlook the part that higher profits play in driving higher stock returns as well.
It's important to note that much of PayPal's leadership team is new in the past year. It seems that this team has made some changes to the business that are starting to lift profit again. That's a huge trend for investors to keep watching.
As mentioned, PayPal stock has dropped about 75% from its high and many investors are certainly hoping for a turnaround. If PayPal's profitability keeps improving while its revenue keeps rising, then a turnaround for the stock price will likely materialize in time.
It's important for investors to keep watching PayPal's business because the positive trend is new. But recent financial results give shareholders good reason for optimism for 2025 and beyond.
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Jon Quast has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends PayPal. The Motley Fool recommends the following options: long January 2027 $42.50 calls on PayPal and short December 2024 $70 calls on PayPal. The Motley Fool has a disclosure policy.
