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Better Buy: Global Payments vs. Square

Investors do not have to be particularly observant to notice that cash is being used less and less in today's economy. As American consumers order more things online and through mobile apps, cash use has steadily declined as various forms of electronic payments have risen. According to Accenture's 2016 North America Consumer Digital Payments Survey, 67% of consumers regularly used cash in 2015. By 2020, that number is expected to drop to 56%.

Given these trends, it only makes sense for investors to want to capitalize on them. Consider the companies that comprise the payment processing industry, which process credit, debit, and mobile payments at the point of sale. Two of the companies in this industry, Global Payments Inc (NYSE: GPN) and Square Inc (NYSE: SQ) gave investors monster gains over the first half of the year, but which of these payment processors makes for the better investment right now? Let's take a closer look.

SQ data by YCharts.

The case for Global Payments

Global Payments has reported strong growth and raised guidance for several consecutive quarters. In the company's 2017 first quarter, adjusted net revenue was $803.9 million, a 68% increase year over year. Adjusted EPS grew to $0.85, a 33% annual increase. The company also raised its guidance and now expects annual adjusted revenue to grow 19%-22% and adjusted EPS to rise 19%-24% over the course of 2017.

In 2016, Global Payments completed its acquisition of Heartland Payment Systems, a move that significantly increased its size and scale and helped it realize considerable cost synergies. This is the primary reason Global Payments improved its adjusted operating margin by 110 basis points to 28.5% in the first quarter and expects it to improve by another 110 basis points by the end of the year.

In the company's first-quarter conference call, CEO Jeffrey Sloan talked about the synergies related to the Heartland merger: "While launching the revenue synergy initiatives necessary to meet our 2017 and longer-term objectives, we have also continued to make substantial progress realizing our expense synergy expectations from the merger. The last significant milestone in this effort is the migration of existing technology environments to our target architecture model, which will be finalized in 2018."

Later in the same conference call, CFO Cameron Bready added that one of the principal reasons for the margin expansion was "the realization of expense synergies from the Heartland merger."

Based on the midpoint of the company's 2017 adjusted EPS guidance, the company is currently valued at an adjusted forward P/E ratio of just a shade over 23. Given the company's growth, guidance, and improving margins, that doesn't appear to be unreasonable.

Both Square and Global Payments have given investors outsized returns through the first half of 2017. Image source: Square Inc.

The case for Square

Square's stock is up an incredible 73% since the beginning of the year, largely due to the company's incredible growth and improving profitability. In Q1 2017, adjusted revenue increased to $204 million, a 39% jump year over year, and gross payment volume grew to $13.6 billion, a 33% increase over the prior year's quarter. Adjusted EBITDA for the quarter was $27 million with a 13% margin, compared to Q1 2016's $9 million loss and negative 6% margin.

Much of this was fueled by Square's subscription and services-based revenue growth. This revenue category consists of premium services that Square upsells to its clients. These services are usually more lucrative than Square's payment processing business and include things like Instant Deposit, Square Capital, and Caviar.

In the company's first-quarter shareholder letter, each of these services was credited for "significantly" contributing to the segment's growth. For instance, Square Capital, a microloan service offered to small and medium-sized businesses (SMBs), "facilitated over 40,000 business loans totaling $251 million in the first quarter of 2017, up 64% year over year." Overall, subscription and services-based revenue was $49 million for the quarter, a whopping 106% increase year over year.

Square is also expanding internationally and recently announced it would be entering the U.K. According to Square's first-quarter shareholder letter, the U.K.'s SMB market might be ripe for the company's services. The market is certainly large, consisting of 5.5 million SMBs which made GBP 1.8 trillion in revenue last year. Furthermore, 70% of the country's consumers would prefer to pay by card, but less than half of the market's SMBs accept card payments. Even better, Square is not just going to offer its payment processing services across the pond (as it has initially done in other international markets it has entered) but will offer all the lucrative services in its subscription and services-based arsenal as well.

Of course, all this growth comes at quite the price. Square is now projecting for 2017's adjusted EPS to be between $0.16 and $0.20. Taking the midpoint of this guidance gives Square a forward P/E over 130 at current prices based on its adjusted EPS. Yikes!

The final verdict

Both Global Payments and Square are fine companies, executing on several different levels and could easily provide investors with market-beating returns in the quarters ahead. That being said, I would personally rather invest in Square given the choice right now. Despite its high price, I believe Square's many extra services and products create a sticky ecosystem that makes it hard for its payment processing customers to leave its services for a competitor. I believe this gives Square a moat that other payment processors will be hard-pressed to match. For this reason, I recently purchased Square shares myself and expect it to have more upside potential in the years ahead than Global Payments.

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Matthew Cochrane owns shares of Square. The Motley Fool recommends Accenture and Global Payments. The Motley Fool has a disclosure policy.