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Better Buy: Square, Inc. vs. American Express

By Matthew Cochrane - Mar 9, 2018 at 8:16AM

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Both of these companies stand to benefit from the world's slow, but massive, shift to electronic payments. But which makes for a better investment now?

By 2026, global credit and debit card payment volume is expected to reach $52.39 trillion, a greater than 150% increase of today's total, according to the Nilson Report. If anything, that might be underestimating the future total. Regardless if that projection is slightly more or less than the actual 2026 total, what cannot be denied is that the general trend is toward a greater use of electronic and digital payments and less use of cash. As emerging markets mature and e-commerce becomes even more commonplace, this trend should only accelerate.

Two companies poised to benefit from this megatrend are Square Inc ( SQ 2.78% ) and the American Express Company ( AXP 1.19% ). Indeed, both companies have outperformed the S&P 500 index over the past year. But which of these companies make for a better investment today? Let's take a closer look at each to see if we can come to a clear conclusion.

SQ Chart

SQ data by YCharts.

The case for Square

Square was founded on the principle of bringing economic empowerment to small businesses. When the company first launched, this meant providing hardware that plugged into smartphones that merchants could then use to accept card payments. In the years since, Square's payment processing business has exploded. In the fourth quarter, gross payment volume rose to $17.9 billion, a 31% increase year over year, and transaction-based revenue grew to $525 million, a 30% increase year over year.

The great thing about Square's business model, though, is that its mission of economic empowerment for small businesses has grown into much more than payment processing. Seemingly every quarter, Square introduces a new application or service for its payment processing clients to subscribe to. These features are accounted for in Square's subscription and services-based revenue segment. In the fourth quarter, this segment once again experienced explosive growth, as revenue came in at $79 million, a whopping 96% increase year over year.

Customer pays at a Square point-of-sale with smartphone using contactless payments.

Both Square and American Express have outperformed the market over the past year, but which is a better buy now for investors? Image source: Square Inc.

There are several such features that now comprise Square's subscription and services-based revenue segment, but the three that are consistently called out for driving most of the revenue are Caviar, Instant Deposit, and Square Capital. Originally acquired as a restaurant delivery service, Caviar is now a robust food-ordering platform that allows customers to place their orders ahead, either online or through a mobile app. Instant Deposit is a feature that allows sellers instant access to their money after a customer makes a purchase, a process that traditionally takes a few days. Square Capital is a business loan platform for small businesses; in the fourth quarter, Capital facilitated 47,000 business loans totaling $305 million, up 23% year over year.

Besides being lucrative and contributing mightily to Square's top and bottom lines, these services also make Square's entire ecosystem incredibly sticky, making it harder for Square's clients to abandon the company's core payment processing services.

In Square's Q4, adjusted revenue rose to $283 million, a 47% increase year over year, and adjusted EBITDA grew to $41 million, a 38% increase year over year. As I'm sure you can guess, this kind of growth does not come at a cheap valuation: Based on the midpoint of its full-year adjusted EPS guidance, Square is currently trading at a forward P/E ratio of 102. The company does not pay a dividend or buyback shares, though that is probably wise as it is going through a nascent hyper-growth stage.

The case for American Express

Since losing Costco Wholesale's co-brand card business, American Express has focused on growing its loan portfolio through initiatives with existing customers and by increasing acceptance with merchants.

In the company's 2017 third-quarter conference call, AmEx management stated that 50% of its loan growth had come from existing account holders. During that conference call, CFO Jeffrey Campbell called out the success the company has had in recent quarters after enhancing the rewards benefits to its card holders:

The thing you need to remember, we made a very conscious decision late last year, early this year, to make some significant value proposition enhancements in the U.S. in both the Business Platinum card and the Consumer Platinum card. And those are both very substantial and material franchises for us. So it worked tremendously well. We've really exceeded our own expectations even in terms of Card Member engagement, new Card Member acquisition as well as continued, really, de minimis attrition rates.

These reward benefits involved greater airport lounge access for frequent travelers and newer reward options the company experimented with, such as Uber credits. Of course, it also doesn't hurt that the company is consistently recognized for its strong customer loyalty and satisfaction rates within the credit industry.

In an effort to be accepted by more merchants, OptBlue is a program designed to get smaller-sized businesses to take American Express as a method of payment. The program offers incentives to merchants who accept AmEx cards such as free window signage, placement on Amex's ShopSmall map, and even the ability to create free online ads. As it expands its merchant coverage, the company's discount rate, the fees retailers pay for card payments, is dropping, but AmEx management insists this is a strategic decision designed to drive revenue growth.

In the company's fourth quarter, 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, once adjusted for the one-time effects of the Tax Cut and Jobs Act. Based on the midpoint of its full-year 2018 earnings-per-share guidance ($7.10), AmEx trades at an attractive forward P/E ratio of 13.5. The stock pays a quarterly dividend of $0.35, giving it a yield of 1.46% and a low payout ratio of 24%. The company suspended its buyback program for the first half of 2018 due to impacts from the tax legislation, but it expects to reimplement it in the second half of the year.

The final verdict

I believe American Express can be had at nice valuation right now, and I would not be at all surprised if it were to beat the market going forward. For more conservative investors looking for a solid company trading at a reasonable value, and paying a growing dividend, it just might fit the bill. That being said, between these two stocks, I prefer Square for its higher ceiling and growth rate. Square's culture of innovation is responsible for a slew of new services and products that are being introduced to customers at a near-dizzying rate, each of which can act as a gateway drug to Square's entire ecosystem of products. The end result is a sticky suite of services that make leaving Square's ecosystem an extremely difficult thing for businesses to do.

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.

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Stocks Mentioned

American Express Company Stock Quote
American Express Company
AXP
$168.93 (1.19%) $1.98
Square, Inc. Stock Quote
Square, Inc.
SQ
$194.78 (2.78%) $5.27

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