2022 has been a reminder that market-beating stocks don't need to be the highest-growth and riskiest bets. Sure, I'm a fan of sprinkling some moonshots into my portfolio. However, companies that produce consistent and profitable growth are the best long-term investments.
With interest rates on the rise and monetary policy at the Fed tightening up, the financial services and technology industry have been hit particularly hard. But not all fintech stocks are created equal. FactSet Research Systems (FDS -0.56%), Nasdaq (NDAQ -3.22%), and PayPal Holdings (PYPL -1.45%) are three potential market-beaters over the next five years. Here's why.
1. FactSet Research: The stable software provider hiding in fintech clothes
FactSet is not an oft-followed name among fintech stocks, but I think it should be. The company is in its fifth decade of existence, providing financial service customers with critical information on industries and markets since 1978. The company boasted about its 41st straight year of revenue growth in 2021.
That statistic alone is impressive, but this research software provider's long-term profitability growth is *what's really impressive. Since its IPO in 1996, free cash flow per share (the metric we will be using for all three stocks here) has risen over 5,000%. That's the real secret ingredient that has made FactSet a consistent market outperformer for years -- including over the last one-, five-, and 10-year periods.
Data by YCharts.
FactSet is still delivering on this metric. Though organic annual subscription value growth (which excludes the effect of acquisitions on the value of customer software subscriptions) grew "only" 10% year over year in the last quarter, total revenue was up 22%. That was thanks to two financial software peer acquisitions last year (Cobalt Software and CUSIP Global). But thanks to FactSet's ability to unlock the value of bolt-on services, adjusted operating profit was up nearly 42% year over year.
With data only growing in importance for organizations of all types, FactSet's tools designed to speed up understanding of industries and their financial makeup should continue gradually expanding for many years to come. The company also uses excess cash to repurchase stock and pay a modest dividend. Shares currently trade for 30 times trailing-12-month free cash flow. That's not an unreasonable price if you believe FactSet's two new acquisitions will keep the bottom line rapidly rising for at least the next couple of quarters -- and for the business overall to keep growing at a steady pace for the foreseeable future.
2. Nasdaq: It's a stock exchange, it's a stock index, it's a business!
The Nasdaq stock exchange (where a lot of tech and fintech companies list their shares for public trading) and the Nasdaq Composite Index (one of a few common collections of stocks we use as a benchmark every day) are familiar features of the investment world. The company responsible for both -- Nasdaq Inc. -- is itself a stock worth getting familiar with.
Like FactSet, Nasdaq has been around for a very long time, founded in 1971 and debuting as a publicly traded company in 2002. Today, Nasdaq is the owner of multiple stock and asset exchanges in the U.S. and Europe. Since asset prices tend to rise over time, Nasdaq has enjoyed gradual growth for years (since it earns transaction and stock-listing fees from market participants based on general asset values).
It's a classic tollbooth-like business model, and the consolidation of various exchanges over the years has certainly helped. Nasdaq's free cash flow per share has risen nearly 4,000% since 2002, helping it handily outperform the market overall as well.
Stock exchange services will remain a critical component of the global economy as businesses tap investors for capital and investors buy businesses to grow their wealth. But in recent years, Nasdaq has begun transitioning from a traditional transaction-based model to more subscription software services. Offerings include data on markets and finance, as well as environmental, social, and governance (ESG) advisory solutions for organizations looking to update their operations to address corporate concerns.
Revenue increased just 6% year over year in the latest quarter, but adjusted earnings were up 9%. Another frequent share repurchaser, Nasdaq could continue beating the market over the next few years thanks to its highly profitable operation and transition to software solutions.
3. PayPal: The online payments provider built to last
I prefaced PayPal with a discussion of FactSet and Nasdaq because of what I hope PayPal will one day become in the fintech space: A steady grower that makes judicious use of its profitability to enhance shareholder value. While FactSet and Nasdaq have both been market-beating investments (including over the last year during the bear market of 2022), PayPal has been anything but. The online payments juggernaut has tanked 73% in value over the last 12-month stretch.
PayPal's management didn't do a great job broadcasting the big cool-off in e-commerce spending from early on in the pandemic. Hopes were high headed into 2022, with management forecasting at least a 19% year-over-year increase in total payment volume growth. But fast-shifting consumer spending driven by inflation and rising interest rates quickly changed that outlook. In the first quarter of 2022, guidance was downgraded for total payment volume to expand just 13% to 15%.
Despite falling expectations for growth, though, PayPal (and its Venmo app-based money tool) is still in good shape. Tens of millions of consumers and businesses rely on its collection of digital payment tools every day. And the company generated $4.95 billion in free cash flow over the last year, a healthy margin of 19%. Since getting spun off from former e-commerce site eBay in 2015, free cash flow per share has risen nearly 2,800%.
PayPal's days of rapid growth might be over, but there could be many more years of more modest and profitable expansion since app-based money management and payments aren't going anywhere. The balance sheet is in tip-top shape too. Cash and short-term investments totaled $7.97 billion, long-term investments were at $7.15 billion, and debt was $8.22 billion as of the end of March. Eventually, I expect PayPal to start returning excess cash to shareholders with share buybacks -- maybe even a dividend someday -- a template for success that has made FactSet and Nasdaq winning stocks for decades. Trading for just 19 times trailing-12-month free cash flow, PayPal looks like a market-beating opportunity over the next five years.
