It's been a wild year for the financial markets, but thanks in part to federal stimulus and relief money sent to households, e-commerce and related digital payments companies have been more than holding their own. PayPal (PYPL -0.27%) is one of them, reporting accelerating growth in Q2 2020. By contrast, Mastercard (MA 0.07%) and its global digital payment processing network hasn't fared so well, although its long-term outlook remains positive.
Full disclosure: I own both stocks, and think PayPal and Mastercard will have plenty of growth in the decade ahead. But one of them looks like the much better stock buy at the moment.
E-commerce and digital wallets get a shot in the arm
PayPal's Q2 2020 report card, covering the period from April to the end of June and encompassing the worst of the economic lockdown, was stellar. Total payment volume (TPV) grew 29% year-over-year to $222 billion, leading to a 22% increase in revenue to $5.26 billion. As PayPal's transaction volume grows, it's leading to even faster bottom-line returns. Operating income grew 35% to $951 million, and earnings per share boomed 86% -- helped in large part by PayPal's investment in South American e-commerce leader Mercado Libre (MELI -0.00%).
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While the resurgent rate of growth is sure to ease up eventually, PayPal thinks the beneficial effects from the pandemic for e-commerce and digital payments have room left to run. With net new account additions increasing 21% in Q2 (for a total of 346 million accounts at the end of June) and mobile payment and digital wallet subsidiary Venmo growing its TPV 52%, PayPal thinks revenue will grow by a similar rate to the second quarter during the second half of 2020. The stock has a steep price tag -- over 42 times trailing 12-month free cash flow -- but it's not an unreasonable amount if PayPal's growth expectations prove correct.
Looking beyond 2020, PayPal is already well-positioned to capitalize on the continuing gradual migration to digital commerce and banking services. Specifically, the company rolled out in-store touchless QR code payments for small merchants, and it is working on a system for large retailers as well (CVS Health's pharmacy business is in an early testing phase of the service). A Venmo credit card will debut later this year as well, and building out integrated banking services within Venmo and PayPal is going to be the focus going forward -- from online shopping tools from last year's acquisition of Honey, to credit card rewards management and basic budgeting tools.
At the end of June, PayPal had $16.2 billion in cash and investments and $9.0 billion in long-term debt. With momentum on its side and the firepower to continue acquiring new users here in the states as well as abroad, there's a lot to like about this e-commerce and money management company.
Global payment networks are down, but not out
Digital transaction network operator Mastercard -- along with the other half of the global transaction network duopoly Visa (V 0.49%) -- didn't do nearly as well over the spring months. The value of payments it processed declined 10% to $1.4 trillion in Q2, leading to 19% and 31% tumbles in revenue and net income, respectively. While Mastercard's payment services also encompass the booming e-commerce industry, most transactions around the globe still occur in person with a debit or credit card. Thus, as much of the world was in some form of lockdown, this war-on-cash stock struggled.
But as the global economy rallies, Mastercard is sure to rally as well. Various expectations call for the global digital payment industry percentage growth to be at least in the teens each year through 2025 as more people around the globe ditch cash in lieu of a card. The immediate-term outlook is foggy at best, but the increased dependence on digital transactions this year will eventually play in Mastercard's favor.
Along the way, the company has also been investing in data security services and other fintech to supplement its bread-and-butter business. I fully expect this investment activity to continue. Even in lean times, Mastercard generates incredible profit margins -- specifically, net margin of 42% in Q2, with net income totaling $1.4 billion on revenue of $3.3 billion. And besides using some of its cash generation to purchase smaller, fast-growing firms, Mastercard pays a 0.5% annual dividend yield, and repurchases stock as well (reportedly over $1.0 billion-worth in July alone after the company put the repurchase plan back into effect).
With its long-term potential, Mastercard also trades for a steep premium -- 44 times free cash flow, even though 2020 will go down as a dud. But with $11.5 billion in cash and investments and $12.5 billion in debt, Mastercard is in good shape to eventually resume its expansion.
Which is the better buy?
In the next decade, I think both PayPal and Mastercard could be knocking on the door of the trillion-dollar market cap club. I thus own both and don't plan on selling either. But with both stocks trading at similar price-to-free-cash-flow ratios, PayPal's higher rate of growth, more concentrated exposure to e-commerce, and higher net cash balance and lower indebtedness make it look like the better buy right now.
