Zip Co Ltd (ASX: ZIP) shares are trading around $2.02 on Wednesday.
This means that for the buy now, pay later stock to double from here, it would need to reach $4.04.
That sounds like a big ask. But when I look at where earnings are expected to go over the next few years, I don't think it is out of the question.
Image source: Getty Images
Earnings could do plenty of the work
The first thing I would want to see is Zip delivering on its earnings forecasts.
Consensus estimates point to earnings per share (EPS) of 15 cents in FY27, rising to 18 cents in FY28, and 22 cents in FY29.
That represents a 20% increase between FY27 and FY28, followed by another 22% increase in FY29.
At today's $2.02 share price, Zip is trading on a P/E ratio of around 13.5 times forecast FY27 earnings. That falls to roughly 11 times FY28 earnings and a little over 9 times FY29 earnings.
I think those numbers explain why I can see a path towards a much higher share price.
If earnings keep climbing while the share price barely moves, Zip shares would become progressively cheaper. At some point, I think investors could become willing to pay more for that growth.
What valuation would $4.04 require?
At $4.04, Zip would trade at roughly 27 times forecast FY27 earnings.
That is much more demanding than today's valuation.
But against the FY28 estimate, the P/E ratio falls to around 22 times and using FY29 earnings of 22 cents per share, it would be around 18 times.
That does not strike me as an impossible valuation if Zip is still producing robust earnings growth by then.
What would need to go right?
For those forecasts to become reality, Zip needs to keep growing the underlying business.
One part of that is continuing to win a greater share of the payments market in the United States and Australia. If more consumers use Zip and more merchants offer its payment options, transaction volumes should have room to keep expanding.
I would also want to see the customer base continue growing without Zip sacrificing credit quality in pursuit of that growth.
That means keeping bad debts under control as more users and transactions move through the platform.
If Zip can combine rising payment volumes and user growth with disciplined lending, I think the earnings outlook becomes much easier to believe.
And if the company can build a consistent track record of doing that, investors may eventually be prepared to pay a higher multiple for those earnings as well.
Foolish takeaway
I don't think Zip shares need an extraordinary set of circumstances to double in value.
If Zip keeps taking market share, grows its customer base without letting bad debts get away from it, and reaches EPS of 22 cents by FY29, a $4.04 share price would represent less than 19 times earnings.
For a company still growing strongly at that point, I think that could be achievable.
