Even if cryptocurrencies are the next big thing, picking the winners won't be easy. With nearly 1,600 digital currencies vying for a top spot, it's likely that the vast majority (99% or more!) will ultimately end up worthless, making them the equivalent of a new-age lottery ticket.
Investing in today's winners is no sure bet, either. The top 10 digital currencies are already valued at approximately $310 billion, suggesting that the best returns are in the rearview mirror -- assuming that those at the top of the pack can hold their dominant position.
Some established financial stocks offer exposure to the payments industry, at market valuations that could lend themselves to high returns over the long haul. Here's why these three Motley Fool investors view Bank of America (NYSE:BAC), Discover Financial Services (NYSE:DFS), and Square (NYSE:SQ) as better bets on the future of the financial world.
Not your token bank
Sean Williams (Bank of America): Last year, the aggregate market cap of all cryptocurrencies soared by more than 3,300%. This year, they've mostly been a disaster. Rather than investing hard-earned cash in virtual currencies, I'd suggest investors consider a more tried-and-true name in the banking industry: Bank of America.
Bank of America is a company I've held for going on seven years, and I don't have any intention of selling anytime soon. Following the Great Recession and more than $60 billion in aggregate settlements, Bank of America is now a better-capitalized bank than at any point in its recent history. And, as we've seen time and again in the banking industry, consumers and investors are willing to forgive and forget past transgressions in a relatively short time period.
One aspect of Bank of America I particularly like is the company's interest rate sensitivity, given that we're in a period of monetary tightening by the Federal Reserve. According to the company's first-quarter 8-K filing with the Securities and Exchange Commission, a 100-basis-point shift higher in the yield curve would result in $3 billion in added net interest income over the next 12 months. This would almost entirely flow into pre-tax profit given that we're talking about existing loans, many of which are variable rate. With the Fed expected to raise rates either three or four times in 2018, Bank of America's net interest income should be on the rise.
It's also worth noting that Bank of America should begin to really see dividends from the passage of the Tax Cuts and Jobs Act, which wound up pushing down its effective tax rate by nine percentage points. Overall, first-quarter pre-tax income jumped 15% to $8.4 billion, and the all-important return on assets vaulted over the 1% mark to 1.21% in Q1 2018.
If there's a fault to be found, it's that Bank of America is currently valued at 1.8 times its tangible book value (TBV). Traditionally, a valuation of two times TBV is considered "fair" for banks, suggesting that Bank of America's near-term upside might be a bit limited. However, as net interest income expands, tax cuts work their magic, and management passes along ever-increasing shareholder returns via buybacks and dividends, Bank of America should have a decent shot to outperform over the long run.
Discover a better way to pay
Jordan Wathen (Discover Financial Services): I love the payments business, but what I love even more is when a payments network is married with the opportunity to deploy billions of dollars in loans at double-digit interest rates.
In an intensely competitive market for credit cards, Discover stands out. That's because it shies away from the "spend-centric" model that so many credit card companies aim for, instead turning its sights to middle class customers who will carry a balance from month to month, and thus pay interest on their balances.
As other issuers compete on rewards alone, Discover's value proposition isn't purely based on the economic value of every swipe. It offers U.S.-based customer service by phone 24/7, something most issuers offer on their top-tier cards only. And its free "cash over" service allows cardholders to get cash back at the point of sale with their credit card instead of making a separate trip to an ATM.
Discover trades at about 12 times earnings (roughly in line with its five-year average), a multiple that reflects the cyclical nature of the credit card industry. And while it's easy to believe earnings are closer to a peak than a trough given that credit card losses are starting to rise after years of low loss rates, I believe earnings can grow thanks to a favorable tax tailwind and Discover's growing base of low-cost deposits that should drive margin expansion over time.
It's hip to be Square
Dan Caplinger (Square): I'm a big believer in looking at companies that have more than one way to make money, and the risks involved with the cryptocurrency industry make it vital -- even for investors who are excited about the space -- to hedge their bets. Square is a good example of how you can get a measure of cryptocurrency exposure while still having opportunities for long-term success even if bitcoin and its peers turn out to be one of the biggest investment bubbles in history.
Square is best known for its relatively simple payments business, with a platform that allows even the smallest businesses to accept credit and debit cards and other forms of payment more easily and efficiently. Over time, the company has added increased functionality to its platform, including the ability to buy bitcoin using its Cash App peer-to-peer payments service. That immediately captured the attention of crypto-investors, but Square's long-term success stems from its ability to use the information it gathers on customer spending and find ways to monetize it more directly. By positioning itself as a holder of key information for its merchant-customers, Square could be a big winner even if bitcoin ends up going nowhere.