Motley Fool
0
All posts from Motley Fool
Motley Fool in Motley Fool,

The Three Best Stocks in Fintech

Fintech, short for financial technology, is the practice of incorporating new and innovative technologies to better perform traditional financial services. Fintech applications include everything from the fairly mundane, like online bank accounts, to the much more exotic, like blockchain technology and bitcoin. While there are several ways to invest in this growing trend, I believe three leaders in this field stand out in the universe of publicly traded companies.

Mastercard Inc (NYSE: MA), PayPal Holdings Inc (NASDAQ: PYPL), and Square Inc (NYSE: SQ), are all fintech front runners, pioneering innovation in their spaces ahead of their peers. This year, these three stocks have all rewarded investors with out-sized returns, crushing the market in the process. Let's take a closer look at all three to help determine why these companies might make the best fintech investments right now.

SQ data by YCharts

Mastercard improving payment security and convenience? Priceless.

In the past couple of years, Mastercard has introduced a number of innovative products and features that enhance payment convenience and security.

In 2016, Mastercard introduced its Mastercard Identity Check, more popularly known as "Selfie Pay." The optional program lets users take pictures of themselves with their smartphones to authenticate certain transactions. Also this year, the company launched the AI-powered Decision Intelligence platform, a service that, according to the press release, "uses artificial intelligence technology to help financial institutions increase the accuracy of real-time approvals of genuine transactions and reduce false declines."

Of course, Masterard's innovation didn't stop once the calendar year changed. Earlier this year, Mastercard acquired NuData Security, a company specializing in the use of passive biometrics to determine whether transactions being made are legitimate or fraudulent. NuData builds digital profiles for users, which includes characteristics such as how they type and hold mobile devices. The service then uses these profiles to compare how closely they match that user's future transactions. Mastercard also introduced a card with a fingerprint reader embedded in it.

In addition to added security, these measures also add simplicity to transactions, making the payment experience more frictionless and far less of a hassle. After all, if Mastercard can determine if a transaction is fraudulent by how I type or hold my phone, I won't have to remember a kajillion different passwords or answer five security questions every time I want to make a purchase. Quick, what was your college roommate's childhood pet's name?

Fortunately for investors, it is easy to see how this innovation translates into the bottom line because Mastercard reports revenue for its security, data analytics, loyalty program management, and consulting services under what it refers to as its "Other Revenues". Before its most recent quarter, this was Mastercard's fastest growing segment, regularly growing by more than 20% year-over-year. This past quarter, because it recategorized some of its Asian loyalty service revenue, the segment only saw 13% revenue growth for a total of $561 million. Without this revenue reclassification, the revenue growth would have been 18%. In its first quarter, Mastercard's net revenue increased by 12% and its EPS grew by 16% over the prior year's first quarter.

This revenue stream gives Mastercard's numbers a bit more oomph and makes it one of the best stocks in fintech. 

PayPal's mobile commerce lead

In 2014, mobile commerce accounted for a little more than 11% of the $303 billion domestic e-commerce total. By some estimates, that could balloon to 45% of e-commerce, or about $284 billion, by 2020. PayPal appears to be better-positioned than any other company to capitalize on this trend.

In 2016, PayPal facilitated more than $100 billion of total payment volume originating from mobile devices. In 2017, this number looks to go up significantly. In the year's first quarter, PayPal handled $32 billion in mobile payment volume, a 51% increase year-over-year. Much of this mobile growth can be attributed to PayPal's One Touch feature.

PayPal is poised to capitalize on growing mobile commerce trend. Image source: PayPal Holdings Inc.

Once users opt-in to One Touch on a given device, they can stay logged onto their PayPal account on that device. This means they can simply click on the PayPal button when they desire to make a purchase using that device instead of entering in the normally required check-out information like a credit card number and billing address.

The program has proven to be incredibly effective. In a comScore study performed last year, PayPal's online conversion rate was 87.5%. The next highest conversion rate by a payment method barely cleared 50%. This means that once a potential customer added an item to a digital shopping cart, those that used PayPal completed the transaction almost nine times out of ten. Consumers who used competing methods of payment barely completed the transaction half the time. When the company reported its first quarter, over 53 million consumers had opted into the program and more than 5 million merchants accepted it at checkout.

Is it time for investors to go Square dancing?

The payment processor industry was once a largely commoditized service space. Basically, payment processing companies had to offer merchants hardware that accepted plastic at the point-of-sale. That has changed, in large part, due to what Square has brought to the table. Square's original goal was to make it much easier for small merchants to accept card payments. It accomplished this by allowing a small iPhone or iPad attachment to accomplish what once required much bulkier hardware. Square has continued to innovate in the space, introducing software that allowed Square vendors to process EMV chip-embedded cards faster and introducing platforms that are specific to different merchants' needs, like Square for Retail.

Square continues to find ways to innovate around traditional points of friction in the payment processing space. Image source: Square Inc.

Square is now reaching beyond its core competency to innovate in other areas of payments as well. For instance, its hugely successful Square Capital program offers small- and medium-sized businesses microloans not often available for these businesses through traditional banks. Its Instant Deposit service allows its clients to receive funds instantly upon swiping a customer's credit or debit card; a process that traditionally takes up to three to four days, creating cash flow problems for small businesses. Caviar, acquired in 2014 as a restaurant delivery service, is now a much more robust food platform offering a mobile order-ahead feature available for use by subscribing restaurants.

These additional services have proven to be lucrative for Square. Reported under its subscription and services-based revenue, the category grew an incredible 106% year-over-year and contributed to the company's adjusted revenue annual growth of 39%. Based on the midpoint of the company's guidance for full year adjusted earnings, the company sports a nosebleed-level forward P/E of almost 150. But the innovation the company shows is leading to outsized growth and investors in the company have been richly rewarded thus far this year.

Foolish takeaway

These three companies trade at a premium valuation to the market, meaning their share prices could be volatile over the short term. But Foolish investors know the best way to capture significant capital gain returns is by investing for the long term. These companies have shown the continued ability to leverage technology to transform the way financial services are performed. In all three of these companies, innovation has directly led to long runways of top- and bottom-line growth. While these stocks might look expensive now, it might not be long before investors look back at these prices wistfully.

10 stocks we like better than Mastercard
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Mastercard wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of July 6, 2017

Matthew Cochrane owns shares of Mastercard, PayPal Holdings, and Square. The Motley Fool owns shares of and recommends Mastercard and PayPal Holdings. The Motley Fool owns shares of Square. The Motley Fool has a disclosure policy.