The "war on cash" was one of the biggest and sustainable long-term trends in the market today, but the COVID-19 pandemic could be the thing that catapults it into overdrive. As people eschew traditional brick-and-mortar stores and are more reluctant to interact with others, contactless card payments have continued to take market share in the pandemic. 

So while overall spending is depressed right now, on the other side of the pandemic, digital payments should continue to eat up market share, especially in developing markets that have more traditionally used cash.

Therefore, after the COVID dip in markets, it wouldn't be a bad idea for investors to scoop up a basket of the world's best digital payments stocks. But if you have limited capital available, which "war on cash" stocks should be first in line?

A woman wearing a face mask holds her phone up  to a digital card reader.

Image source: Getty Images.

An exceptional moat

No matter if you use a debit card, credit card, or contactless digital payment, non-cash payments all still use the "rails" of the major card networks, the two largest being Visa (V -0.93%) and Mastercard (MA -0.12%). The card network that had the highest growth rate in 2019 was Mastercard, and it's probably the widest-moat digital payments stock out there today, sending it to the front of the line for inclusion in your "war on cash" basket. 

Both card payment networks have deep competitive advantages brought on by network effects. With a history going back to 1966, Mastercard was an early mover in providing payment networks. In this business, size matters; customers want cards that are accepted everywhere, and merchants want to be able to serve customers with the most popular cards. Meanwhile, Mastercard has wisely used its scale to invest in its card network, employ the latest technology, and expand geographically to consolidate much of the non-Chinese payment networks under one of these two behemoths.

This has led to a virtuous network effect that affords both companies high margins. Last year, Mastercard grew its revenue 16% on a currency-neutral basis, as operating margin expanded to an exceptionally high 57.2%. More recently, through its own internal research and development efforts and bolt-on acquisitions, Mastercard has developed analytics services, cyberintelligence services, and loyalty program management and consulting services, which build on the core payments network. Last year, these other value-add services grew 23%, actually accelerating over the prior-year growth, and making up around 16% of total revenue.

Despite its already-massive size as the second largest card network globally, increasing cashless payments combined with new services have allowed Mastercard to grow revenue at a 15% annualized rate over the past four years, with operating income compounding at a higher 17.5%, and diluted earnings per share at an even higher 24.1% annualized rate.

2020 headwinds

Of course, in 2020, Mastercard, like all digital payments companies, has had to contend with coronavirus. Since Mastercard primarily makes money based on the volume of payment transactions, lower overall spending has hurt results, especially in the cross-border segment as international travel has been greatly curtailed.

In the pandemic-plagued second quarter, Mastercard's gross dollar volume was down 10% globally. Because high-fee cross border solutions were down a whopping 54%, overall net revenue fell 19%. However, on the bright side, these metrics improved throughout the quarter. After reaching a low in April, Mastercard revealed its total switched volumes had turned positive year-over-year by the first week of July.

We'll know more about switched transactions since July during Mastercard's upcoming earnings report later this month; likely, growth will be dependent on the economic recovery, which will be dictated by both the pandemic trajectory as well as new stimulus. However, over time, things should eventually improve.

The crisis may actually even accelerate parts of Mastercard's business, such as cyber threat and AI services, which remained in positive territory even in the down second quarter. On the conference call with analysts, President Michael Miebach said:

[A]s you rightly said, there is this accelerated shift to digital, yes, and we see that right now. What does that all -- or what does all of that mean for the business overall? Well, first of all, that accelerates the secular shift to digital payments. So that's all fantastic. But it has a downstream impact into our services, for sure. So more digital transactions versus more cash transactions is more data. More data means more desire and more need for data analytics capabilities, but also to protect that data. So our cyber solutions are going to benefit from that in the long run. We've clearly seen that. As long as the underlying trend to digital continues which we believe it will, our services portfolio which it hits right on to these points, should be benefiting.

In today's age, data insights can bring tremendous advantages for corporations. Ironically, that means many older companies with vast troves of historical data may be at an advantage, should they be able to organize that data and derive valuable insights to make new products and services. That may be one reason large cap stocks have been outperforming small cap stocks since 2013, when many of these data-driven technologies began to be widely used.

A great anchor in the war-on-cash portfolio

Mastercard's stock is up almost 90 times its 2006 IPO price, and at this point, its market capitalization of $330 billion makes one of the largest companies in the world. Moreover, its PE ratio based on 2021 estimates is 37 -- not exactly cheap.

And yet, many new upstart digital payments and fintech companies are even more expensive, while they don't yet have the wide moat and high profitability of Mastercard. Moreover, the global acceleration of digital payments means Mastercard has a good shot of returning to low-to-mid-teens revenue growth as the world economy recovers. When you factor in zero interest rates for  the foreseeable future, and Mastercard's valuation actually looks more than reasonable. Thus, Mastercard offers a unique mix of safety and growth potential that's hard to match, making it an excellent choice to anchor any "war on cash" basket in your portfolio.