Square (NYSE:SQ) is one of the fastest-growing companies in financial services and has become the face of the mobile payments industry in many ways. As it has grown, it is adding services that are mission-critical to the small and medium-size businesses it serves, further entrenching itself in their operations.
But Square is still reliant on major credit card networks like Mastercard (NYSE:MA), which connect merchants with banks and card users. That intermediary position has been extremely profitable for the company and may be hard for Square to overcome as we look at which stock is a better buy today.
The growth battle easily goes to Square
If you're looking for growth stocks, Square is definitely the winner of these two. The company has nearly quadrupled in the past five years, growing more than four times faster than Mastercard.
Square has a big advantage here because it only generates about a quarter of the revenue of Mastercard, so growth is from a much smaller base. If Square didn't win the growth battle, this wouldn't be a comparison at all between these two stocks.
Show me the money
What Mastercard lacks in growth, it more than makes up for by turning revenue into profit. You can see below that its operating margin is 57%; Square is yet to pass breakeven in operations.
It's tough to compare operating margins between a company that's mature like Mastercard and a growing company like Square. But the margin profile today highlights a huge challenge Square will have in the future. The company only keeps about 0.6% of each transaction as revenue, and that needs to cover all the cost of running its business. As Square stands today, it'll never be a high-margin company, but that's why investors are looking at future products for it to generate value.
A platform for growth
Square doesn't just want to be a payment processor, it wants to change the way businesses operate and how consumers use money. On top of payment processing, the company has added services like payroll, marketing, website design, and even loans for businesses. For consumers, Square has an app for transferring money called the Cash app and a credit card that aims to become a central place users interact with their money.
If Square is successful in building its services and ingraining itself more in growing businesses and even consumers' lives, it may be a much bigger company than Mastercard eventually. But investors are betting on an unknown disruption and growth beyond just the payment platform, which is a leap of faith versus a stalwart like Mastercard.
The competitive landscape
Square may be the biggest name in mobile payments, but it's far from the only game in town. It has dozens of competitors that specialize in serving everything from restaurants to coffee shops to large businesses. Square is trying to play in all of those markets, but it faces a lot of competition everywhere it goes.
Mastercard, on the other hand, is in an oligopoly in credit cards. Visa, American Express, and Discover are the other big players, and it would be extremely difficult for an upstart to enter the market. Even as companies like Apple and Google enter the payment market, they usually partner with a credit card company, so Mastercard has a strong moat around its business.
The better buy today
There's no question Square is the disruptor of these two businesses, but I have a hard time getting past how profitable and entrenched Mastercard is in our financial world. Competitively, I worry much more about start-ups disrupting Square's business.
Mastercard isn't a great value at a 42 P/E ratio, but it has a dividend, albeit a small one with just a 0.5% yield.
I think Mastercard is a better buy today, simply because it's shown the ability to make money and has a great competitive moat. Square will continue to disrupt, but until it proves it can grow the bottom line, I'll stick with the more established financial services company.