Better Fintech Stocks: PayPal or Upstart

PayPal (PYPL -4.25%) and Upstart (UPDATE -5.71%) represent two very different ways of investing in the fintech market. PayPal processes digital payments for businesses and individuals, while Upstart helps lenders approve loans using non-traditional data such as a customer’s education history, field of study, GPA, standardized test scores and work history.

Both stocks attracted plenty of bulls during the pandemic-induced rally in growth stocks last year, but fell out as rising interest rates and other macro headwinds crushed the market. PayPal’s stock hit a record high of $308.53 last July, but is now trading at around $80. Upstart closed at an all-time high of $390 last October, but is trading at $23 today. Could some of these defunct fintech plays make a comeback? Let’s take another look at their businesses to find out.

Image source: Getty Images.

How PayPal lost its way

PayPal’s problems started in 2018, then eBay (EBAY -2.32%)its former parent company and major retail partner, began shifting its orders to the smaller Dutch backend software provider Adyen (ADYE.Y -1.61%) in a three-year transition.

PayPal’s revenue rose 19% in 2019, but accelerated to 21% growth in 2020 as the pandemic boosted online sales and temporarily offset the gradual loss of eBay’s business. Buoyed by this acceleration, PayPal proclaimed that it could nearly double its active accounts from 377 million in 2020 to 750 million in 2025 during its investor day last February.

However, PayPal’s revenue rose only 18% in 2021, and it expects only 10% growth this year. That decline prompted it to abandon its goal of reaching 750 million active accounts by February. Instead, it admitted that the loss of eBay to Adyen had cut top-line growth, and it struggled to fill the void with new customers in a post-pandemic world.

PayPal’s adjusted operating margin fell in 2021 and the first half of 2022 as it ramped up spending on new features, battled tough currency headwinds and faced unfavorable year-over-year comparisons with the release of credit reserves in 2021. That’s why it expects its adjusted earnings per share ( EPS) will fall 14% to 16% for the full year.

PayPal’s decline was disappointing, but it’s still growing and the stock finally looks cheap at 17 times forward earnings. But the departure of its longtime chief financial officer, John Rainey, in May, its aggressive expansion into the risky BNPL (buy now, pay later) market, and the controversial proposal to fine individual accounts $2,500 per violation for spreading “misinformation” (which it quickly regressed) all raise bright red flags for the future.

Why Upstart fell off a cliff

The upstart is trying to disrupt legacy credit scoring companies that FICO (FICO -0.91%), which helps lenders approve loans by assessing an applicant’s income level, credit history and other traditional data. Upstart’s non-traditional approach can help these lenders approve supplemental loans for customers with limited employment and credit histories.

Upstart’s revenue increased 42% in 2020, driven by 40% growth in bank-originated loans, then skyrocketed 264% in 2021 as bank-originated loans grew 338% to 1.3 million. Revenue rose another 70% year-on-year in the first half of 2022, but analysts expect just 6% growth for the full year as revenue falls sharply in the second half.

The upstart blames that decline on rising interest rates, which have dampened demand for new loans while also forcing cooperative banks, credit unions and car dealerships to stop financing so many loans. Therefore, the core business – charging these lenders service fees to access the platform – will continue to deteriorate as long as interest rates rise.

Upstart initially only connected its lending partners to potential customers, who kept that debt off its own balance sheet. But in August it declared that it would start funding some of these loans on its own until the macro situation improved. The abrupt shift is risky, as revenue growth is already slowing and analysts expect it to become unprofitable this year.

Upstart’s inventory looks cheap at just twice this year’s sales. However, the depressed valuation suggests that many investors are not entirely convinced that the business model can survive the coming rate hikes.

The better buy: PayPal

I’m not excited about any of these stocks right now. PayPal’s track record of over-promising and under-delivering has cast a dark cloud over its future estimates, while Upstart’s business model was clearly not designed to withstand a sudden rise in interest rates. But if I had to choose one over the other, I’d stick with PayPal because it’s growing faster, it’s profitable, and the inventory is cheap. PayPal’s massive user base of 429 million active accounts also gives it plenty of room to roll out new services and grow revenue — provided management doesn’t keep tripping over its own feet.