Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

Better Buy: American Express Company vs. PayPal Holdings Inc.

By Matthew Cochrane - Mar 2, 2018 at 8:17AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

These two companies might both be market-beating investments in the years to come, but which one is better?

Companies in the financial technology and payments industries have enjoyed excellent returns over the past year. Case in point: Both American Express Company ( AXP 2.57% ) and PayPal Holdings Inc. ( PYPL 0.90% ) comfortably beat the market over the past 12 months. Over that period, PayPal has returned an amazing 85%, American Express 24%, and the S&P 500 16%. Though vaguely participating in the same space, these two companies have very different business models and outlooks, and they will probably appeal to different types of investors. Let's take a closer look at each of them to determine which might be a better fit for your portfolio.

The case for American Express

American Express runs what's called a closed-loop credit card system. That means the company issues its own branded cards, lends money to its account holders, and facilitates the payments on those cards as well. That approach stands in contrast to credit card companies such as Mastercard and Visa, which act as the payment network but not the credit issuer.

Close-up of a credit card showing part of its number.

American Express operates a closed-loop credit card network, meaning it issues its own credit cards and collects interest on the debt of its card holders. Image source: Getty Images.

There are advantages and disadvantages to this model. One big advantage is that consumers pay lots of interest on their credit card debt each year, and, as the debt issuer, American Express is able to collect this revenue for itself. Another advantage is the data AmEx is able to collect on its customers. Before he left the company earlier this year, at the Goldman Sachs U.S. Financial Services conference (as transcribed by S&P Global Market Intelligence), former CEO Kenneth Chenault talked about the data American Express can mine from its customers because of the company's business model:

[A] diversified integrated business model such as ours, which includes both issuing and network businesses across multiple geographies, products, and customer segments, offers major advantages. We have the flexibility to reallocate investment dollars to different parts of the business across different countries as marketplace conditions change. Our closed loop, which combines information from both our issuing and network businesses, gives us access to data that is both broad and deep. Increasingly, the information we analyze in the age of Big Data is a critical ingredient in building value for both card members and merchants.

The company puts this data to good use, as American Express consistently tops rankings for having the most loyal and satisfied customers in the credit card industry.

The primary downside to this business model, however, is that American Express is exposed to credit risk. Lest one forget, credit card debt is riskier than most other types of debt. Fortunately for shareholders, American Express has one of the best underwriting records in the business. In the fourth quarter, the company's net write-off rate was only 1.8%, far lower than its credit card-issuing peers.

Once adjusted for the Tax Cuts and Jobs Act, quarterly revenue rose to $8.84 billion, a 10% year-over-year increase, and earnings per share grew to $1.58, a 73% increase year over year. The top- and bottom-line increases were driven by total loan growth which jumped 14% year over year to $76.1 billion. AmEx's full-year 2017 adjusted earnings per share was $5.87, giving it a reasonable P/E ratio of 16.8. The company pays a quarterly dividend of $0.35, giving it a dividend yield of 1.42% and a payout ratio of approximately 24%.

The case for PayPal

PayPal Holdings can probably best be described as a digital payment platform that allows account holders to pay for purchases (mostly online, but also at a growing number of points-of-sale) and send money to peers. What makes the company especially interesting is that it stands poised to benefit from two major macro trends: e-commerce and mobile commerce.

In 2017's fourth quarter, e-commerce sales grew to $119 billion, a 16.9% increase over last year's fourth quarter, while total retail sales only increased 5.7%, according to the U.S. Census Bureau. In other words, what we all probably observe in our daily lives is true everywhere: More and more shopping is occurring in the digital realm at the expense of brick-and-mortar retail.

Person holding a smartphone showing PayPal app page.

PayPal's mobile payment volume exploded 53% year over year in the fourth quarter. Image source: PayPal Holdings Inc.

Mobile commerce is also growing and will reach 45% of total e-commerce sales by 2020, or approximately $284 billion, according to Business Insider. In the fourth quarter, PayPal processed $48 billion in mobile payment volume, payments that originated from a mobile device, good for a whopping 53% increase year over year. That total represents about 36% of PayPal's total payment volume for the quarter.

PayPal attributes its success in this market to One Touch, a platform that allows account holders to register a device with PayPal. Once registered, users can make purchases from merchants accepting the platform with one click of the PayPal button at a site's checkout page. No more retrieving cards to enter credit card numbers or punching in billing and delivery addresses on small smartphone screens. At the end of 2017, 80 million consumers and 8 million merchants had enrolled in the program, 100% and 60% increases year over year, respectively.

In the company's fourth quarter, non-GAAP revenue increased 26% to $3.74 billion and non-GAAP EPS increased 30% to $0.55. Based on the midpoint of its full-year 2018 earnings per share guidance of $2.27, shares trade at a fairly steep forward P/E ratio of 35.1. The company doesn't pay a dividend but did repurchase $1 billion of shares in 2017 and expects that total to increase in 2018.

The final verdict

First and foremost, I really like both of these companies. I believe, at current prices, that both have better than decent shots at beating the market over the next several years. That being said, given the choice, I currently own PayPal shares and am only watching American Express. That's because I think PayPal could experience explosive growth riding the coattails of e-commerce and, especially, mobile commerce in the years ahead. While American Express trades at a more reasonable valuation, PayPal's growth prospects are just that much better and make it deserving of its premium pricing.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

American Express Company Stock Quote
American Express Company
$156.21 (2.57%) $3.91
PayPal Holdings, Inc. Stock Quote
PayPal Holdings, Inc.
$186.56 (0.90%) $1.67
Mastercard Incorporated Stock Quote
Mastercard Incorporated
$315.87 (0.30%) $0.94
Visa Inc. Stock Quote
Visa Inc.
$194.03 (0.14%) $0.26

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/01/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.