PayPal has seen its stock rise 130% over the last 2 years, and this has caused its price to earnings ratio to really rise. Some analysts are worried, but investors don’t seem to care.
PayPal stock has performed strongly over the last couple of years, moving from $42.55 back in April 2017 to close at an all-time high of $98.07 on Thursday. This works out to a 130% gain in less than 2 years, and has elevated the stock to the point where analysts have really become worried that it may be overvalued.
Earlier in the month, Guggenheim Securities’ Jeff Cantwell lowered their rating of PayPal stock from a buy to neutral over concerns of their price to earnings ratio rising to 32. He remarked that “in our view, PayPal lacks a significant EPS catalyst that would drive our forecasts meaningfully above consensus.”
A week earlier, PayPal released their quarterly earnings report, which came in a little lower than expected, which disappointed investors enough to cause the stock to drop from $94.28 to $90.01, a loss of 4%.
While admitting that the company does have some upside, Cantwell told us that the “positives appear to be well understood, and already reflected in the valuation.” This is generally the case with stocks, to a degree at least, as its current price is reflective of its outlook generally.
What we need to realize though is that stock prices just don’t move by way of earnings expectations, even though earnings outlooks do move stocks to be sure. Markets aren’t static like this though, or we’d just see it move on news and nothing else, news that impacts earnings or other business outlooks.
In other words, if everything we know about the outlook of PayPal was priced in and nothing else determined this, we should stay at $90 a share until we get some more news which would change how we should value the stock, and it would then move in that direction according to the impact of the new information.
Expectations of Increased Demand for a Stock is What Really Matters
We know that this isn’t how things work though, and the missing link is that this also comes down to how much investors are willing to pay for the stock. This part is influenced by a number of things aside from earnings per share or earnings potential, which is why these numbers will only take you so far when looking to predict future stock prices.
If investors just bought stock for earnings purposes, then earnings per share would have much more weight, and in fact this would make common shares function much more like preferred shares, where the goal is to earn income and not capital growth.
Common stocks are mostly about capital growth though, and therefore the focus is mostly placed not on what sort of dividends we may expect, which price to earnings ratios speak to, or how much the company may earn in a quarter, but instead how much the demand for the stock may change, how much capital growth we may expect.
There are therefore investors who may sell or refuse to buy when a stock hits a certain price to earnings ratio, or when earnings reports start to look sluggish, and this does cause demand for it to drop and supply to increase, which are forces that lower prices.
Stocks are more dynamic than this though and there are other reasons why people buy and sell them, anything from buying because you want to buy stock and you’ve heard of the company, or they are an online company that has a big share of the payments market and will probably hang on to or extend this lead, or any number of other reasons.
Analysts also don’t just look to the latest earnings report but will also look further out, perhaps even several years down the road, and investors who are investing for the long term do so as well, including large institutional investors.
While the current outlook may be priced in to some degree, stock investing is essentially speculation, and people will continue to speculate as to where a stock is headed, looking at the current outlook and speculating on how this outlook may change over time.
Momentum also plays into this as well, and a stock moving in one direction or another can make its own waves, where people get on or off just by virtue of the current direction. In our case, PayPal’s direction has been mostly upward the last 2 years, as has the market, and when the market is going up, this means more and more money is invested in stocks, which increases demand and tends to put the price of stocks up independently of any forces particular to the company.
This is the part a lot of analysts tend to not account for properly, where their focus on particular stocks does not account for market forces which surely influence stock prices. It’s not that the current bull trend is all that strong but we’re still moving up, and PayPal surely has moved along with the uptrend since last December in the markets, moving from $78.14 to $98.07, a gain of 25% over the last 10 weeks.
The Stock Price Isn’t Paying Attention to These Concerns So Far
Perhaps even more noteworthy is the move that PayPal has made since this mildly bearish earnings call and the bearish predictions of analysts like Cantwell, who told us then that he didn’t really see any upside for PayPal this year. We’ve moved up nearly 10% since then, which certainly should qualify already, and it’s only been a month since this prediction.
This has caused PayPal’s price to earnings ratio to go even higher, although this doesn’t seem to be bothering the new money that is being put into the stock, and that’s all price increases boil down to really, people stepping up and paying more for a stock.
Bill Carcache of Nomura stepped up to the mic on Thursday and shared a more optimistic view of the company’s stock, and is willing to fly in the face of all the bears that have weighed in on this. These analysts may think that PayPal was overvalued at $90, but investors didn’t think so, and it’s the investors that have the final say.
Even through this most recent rally of PayPal stock, the bears continued to pile on, and back on Monday, Buckingham Research’s Chris Bender also downgraded it from a buy to neutral, citing near term growth concerns and describing them as a “headwind.”
Carcache responded that “while we would not minimize the significance of [growth] deceleration, we see clear evidence that the headwinds that PayPal is facing is transitory and think core growth trends remain solidly intact.” Carcache has a price target in mind of $110 a share, 11% higher than the stock is currently trading at.
Whatever the extent of these headwinds, they might be blowing down a few analysts, but investors remain solid on their feet so far and are forging ahead regardless. When a stock rises 10% since this wind started picking up a month ago, we can’t say that they are doing much to stop or even slow down this stock, at least yet.