Investing in Buy Now, Pay Later (BNPL) Stocks

Buy now, pay later (BNPL) stocks are companies that provide a form of short-term financing. They enable consumers to make an immediate purchase that they pay for over time in installments. BNPL is typically an interest-free source of short-term credit.

Here's a closer look at buy now, pay later financing and the top stocks in the sector that investors should consider.

Understanding BNPL

Understanding buy now, pay later

Buy now, pay later (BNPL) are short-term loans provided by financial technology companies to customers to make purchases from participating retailers that they pay off in installments. Most BNPL loans typically have fixed payments and don't charge borrowers interest or additional fees. The borrower will typically make a small down payment and then make fixed installment payments to pay off the remaining balance.

BNPL companies make money by charging the merchant a fee to help them complete a transaction. This fee is often called a merchant discount rate. Merchants are willing to pay this fee to facilitate a BNPL transaction because it enables them to increase sales. In addition, BNPL companies can also make money by charging interest if the borrower opts for an extended payment plan or late fees if they don't make timely payments.

While providing BNPL loans can be a lucrative and growing source of income for financial technology companies, they are taking on the risk that the borrower won't repay the loan on time. The default risk would increase during a recession when more people lose their jobs and can't afford to make payments. However, one way some BNPL companies are reducing their default risk is by using artificial intelligence (AI) instead of credit scores in underwriting loans. It is often a better predictor of a borrower's potential to default on the loan.

Best buy now, pay later (BNPL) stocks in 2024

Many financial technology companies (fintech) are getting into buy now, pay later financing. Here's a look at three of the best BNPL stocks this year:

1. Affirm Holdings

1. Affirm Holdings

Affirm Holdings (AFRM 5.31%) makes financial products that help businesses grow sales while enabling consumers to spend and save money responsibly. It's a leader in providing BNPL loans.

The company offers borrowers convenient and transparent repayment options. Unlike many rivals, Affirm does not charge hidden or late fees. Meanwhile, it doesn't charge interest as long as borrowers pay in four installments (down payment plus as many as three fixed monthly payments). If consumers opt for an extended payment plan, it charges simple interest instead of compound interest.

Affirm Holdings makes money in several different ways:

• Merchant discount rate: It earns revenue from the merchant by helping them facilitate a transaction.
• Interest: While loans paid off in four installments are interest-free, it earns simple interest on loans with extended repayment plans.
• Interchange fees: It earns a fee when consumers use its virtual credit card on established card networks.
• Loan sales: Affirm will sell a portion of the loans it originates to third parties and recognize a gain (or loss) on the sale.
• Loan serving revenue: It earns a fee for servicing loans sold to third-party investors.

In 2022, Affirm had more than 15 million customers. It generated more than $18 billion in gross merchandise value with an average order value of $307.

2. Block

2. Block

Block (NASDAQ:SQ), formerly Square, is a global technology company focused on providing financial services. The company's platform consists of several building blocks to help businesses grow. It has an integrated ecosystem of tools that include Square, Cash App, Spiral, TIDAL, and TBD.

Block added BNPL to its platform in early 2022 when it closed the acquisition of Afterpay, which it integrated into Square and Cash App. Block paid $29 billion for the Australian company's pioneering BNPL platform. At the time of the transaction, Afterpay operated in Australia, the U.S., Canada, and New Zealand. Meanwhile, its affiliate Clearplay was available in the UK, France, Italy, and Spain.

Afterpay allows customers to make four interest-free installment payments over six weeks while enabling merchants to get paid in full right away. The company charges merchants a fee for each transaction (6% plus $0.30). Afterpay helps boost sales because its customers spend 40% more per transaction and shop 50% more than traditional customers.

Block splits the revenue and gross profit from its BNPL platform between Square and Cash App. During the second quarter of 2023, Square and Cash App each recognized $118 million in revenue and $84 million in gross profit from its BNPL platform.

3. PayPal Holdings

3. PayPal Holdings

PayPal (PYPL 2.9%) is a leader in digital payments. It has a diversified and complementary portfolio of financial technology assets, including brands like Honey, Venmo, and its PayPal digital wallet.

In 2020, PayPal launched its BNPL service. PayPal offers consumers the option to make purchases of as much as $1,500 that they can repay in four installments (one down payment and three bi-weekly installment payments) with no interest, late fees, or credit checks. In addition, consumers can stretch larger purchases out to as long as 24 months with zero money down, although it charges interest for these loans.

PayPal has become an industry leader in BNPL products. Since launching, PayPal has issued over 200 million loans to more than 30 million customers across eight global markets as of mid-2023. In 2022, the company processed more than $20 billion in BNPL volume, a 160% increase from the prior year. PayPal launched an exclusive multiyear relationship with private equity giant KKR (KKR 0.71%) in 2023 to purchase as much as 40 billion euros in European pay-later receivables. The deal freed up $1 billion in PayPal's capital, enabling it to increase its share repurchase plan from $4 billion to $5 billion in 2023.

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Should you invest in BNPL stocks?

BNPL is a rapidly growing form of short-term financing. Affirm, Block, and PayPal are among the early leaders in the sector. The growth potential of BNPL makes them compelling stocks to buy for those seeking to cash in on this trend.

However, BNPL has risks. A recession could cause increased defaults across the sector, affecting growth and profitability and likely weighing on share prices. Investors need to ensure they understand how BNPL works before investing in the sector.