The war on cash is a megatrend impacting consumer behavior around the world. The global e-commerce market will grow 11.7% annually and reach $7.7 trillion by 2025, according to Grand View Research estimates.
PayPal is winning over shoppers
PayPal shareholders have been handsomely rewarded, with shares up 150% since it separated from eBay in 2015. Management's "customer choice" strategy focused on forming partnerships with other payment providers to give customers more payment options has been a major driver of Paypal's success.
This initiative has led to growing engagement among PayPal's 244 million customer accounts and growth in total payment volume (TPV) that doesn't seem to want to slow down. In the last quarter, TPV grew 29% year over year, an important metric to watch as PayPal generates virtually all of its revenue from charging a small fee on each payment. Strong growth in TPV fueled revenue growth of 23% year over year in the last quarter, while adjusted earnings per share climbed an impressive 28%.
It's not only the e-commerce megatrend that has investors buying the stock but also PayPal's consistency. For over a decade, PayPal has posted greater than 20% growth in TPV. Even more exciting, customer account growth has accelerated over the last year. In the second quarter, the company posted a 15% year-over-year increase in new accounts, a faster rate of growth than the year-ago quarter's 12%.
Clearly, customers find PayPal's value proposition to be very compelling, including its user-friendly apps (including Venmo), features (One Touch), choice of payment options, and availability at more than 19.5 million merchants.
Speaking of merchants, PayPal's recent $2.2 billion acquisition of iZettle extends the payment leader's addressable market to merchants looking for a quick and easy digital checkout solution in their stores. When the deal closes this quarter, PayPal will gain in-store capabilities in 11 markets, including Europe and Latin America.
Of course, consistent high growth does not come cheap. Paypal stock trades at 37 times management's non-GAAP earnings guidance for 2018, which projects year over year non-GAAP earnings growth of roughly 20%.
Square is winning over businesses
By contrast, Square's strategy focuses on making it easier for entrepreneurs and small merchants to quickly and painlessly set up point of sale systems for electronic payments, either via credit card or a customer's mobile wallet.
Like PayPal, Square generates most of its revenue (77%) from transaction fees, which grew 30% in the second quarter to $625 million. But the company also offers subscription plans and other services that allow merchants to access essential management tools, such as analytics, invoices, payroll, and marketing. Revenue from services and subscriptions made up only 16% of Square's revenue in the last quarter, but it's the company's fastest-growing category with revenue more than doubling in the recent quarter to $134 million.
Such strong growth in subscriptions and services reflects the close attachment between merchants and the digital payment leader.
Square is building a complete e-commerce platform for individuals and businesses across hardware (card readers and Square Registers), software, and its Cash App (peer-to-peer payments). It also offers a service called Square Capital that issues loans to small businesses. Other services, such as Caviar (an online food ordering/delivery platform) and Square for Restaurants (a point-of-sale system designed specifically for the needs of restaurants), show that management wants to tailor Square's platform to fit specific industry needs and grow its addressable market, currently estimated to be more than $70 billion.
Square is a much smaller business than PayPal, with trailing 12-month revenue of $2.7 billion compared to PayPal's $14.5 billion. However, Square is growing faster. This year, management is calling for revenue growth of 55% and adjusted earnings-per-share growth of 56%. This kind of growth has caused the stock to soar 450% since its IPO in 2015, with shares trading for a frothy 163-times-forward-earnings multiple.
Which is the better buy?
Both companies offer huge growth potential and provide essential services in their respective markets. While Square primarily focuses on serving businesses, PayPal's main focus has been consumers. Although both companies show promise, I'm going to have to side with PayPal here.
Paypal's acquisition of iZettle shows that PayPal not only wants a piece of Square's $70 billion market opportunity but also wants to be a complete digital payments solution for individuals and merchants all over the world. PayPal already operates in bill payment, mobile payments, peer-to-peer payments, and soon to be point-of-sale solutions for small businesses.
Comparing Square's and PayPal's forward P/Es to expected growth based on guidance shows Square trading for a PEG ratio of almost 3 times, while PayPal's is less than 2 times.
Because of PayPal's lower valuation and it's ability to be a one-stop shop for everyone, PayPal is the better buy for investors today.