Financial services is an ancient industry, and in recent decades, it's often lagged behind others when it comes to improving the user experience. But this has been changing.
One of the most notable trends this century has been the growing popularity of fintech, or financial technology. Using the connective power of the internet, fintech businesses have made traditional financial products simpler and more accessible to customers, winning monumental growth for themselves. This makes it an attractive place to look for investing opportunities.
There are lots of different fintech enterprises out there serving different needs, so investors don't need to pick a single fintech winner. Instead, they can allocate their capital to multiple different businesses in the space. Let's take a closer look.
Image source: Getty Images.
The war on cash
It can be smart for new fintech investors to first look at the payments industry. Visa (V -0.23%) and Mastercard (MA 0.07%) deserve serious consideration as starting points. Combined, these companies processed $5.4 trillion in payments volume just in this year's second quarter. In total, they have 7 billion branded cards in circulation that are accepted at tens of millions of merchant locations worldwide. That scale results in powerful network effects. Besides simply holding dominant competitive positions, their processing networks are deeply entrenched in the world's financial infrastructure, which makes them incredibly profitable. In the last 10 years, the operating margins of Visa and Mastercard have averaged 66% and 55%, respectively. Unsurprisingly, this has led to the generation of tremendous amounts of free cash flow.
There are other payments companies to pay attention to. Having been founded more than two decades ago, PayPal (PYPL 2.90%) was a digital payments pioneer, providing consumers with services that make it easy to pay for things online and send money to friends, and letting merchants more seamlessly accept online payments. The business has 431 million active accounts today and processed $1.4 trillion in total payment volume in the last 12 months.
Block (SQ 2.32%) has come a long way from its days selling the small accessory that turned a smartphone into a point-of-sale terminal. The company operates two budding payment ecosystems in Square and Cash App, which combined registered $1.9 billion of gross profit in the most recent quarter. On the merchant side, Square offers a vast array of hardware, software, and financial services products. And Cash App, now with 54 million monthly active users, is a popular personal finance tool that for some consumers can be a substitute to having a traditional bank account.
Even Apple (AAPL -0.35%) is rapidly rising up the ranks in adoption. Apple Pay is the second-most widely adopted digital wallet in North America and Europe, after PayPal.
Niche service providers
Outside of payments, which has proven to be a very lucrative industry, investors should know about more specialized fintech companies that offer unique services.
SoFi Technologies (SOFI 3.69%) is a digital banking provider that offers numerous services, like checking and savings accounts, credit cards, and student loans, geared toward a younger, affluent demographic. The online bank's deposit base continues to grow with each passing quarter. And its management team believes it can achieve positive net income in the fourth quarter of this year.
Artificial intelligence (AI) is on every investor's mind these days. While this technology has a range of potential applications, it's already being used in the financial services industry.
Lemonade (LMND 1.64%) uses 50 different machine learning models throughout the organization to better serve customers and manage risk. Unlike incumbent insurers, it operates no physical branches, instead utilizing a completely digital model. Lemonade says that someone can sign up for a new policy, or have a claim approved, in minutes.
Since it was founded in 2012, Upstart's (UPST 2.76%) entire business model has been based on using AI to better analyze a borrower's ability to pay back a loan. Upstart offers its tech-enabled platform to lending partners who hope it can expand their reach by approving more borrowers, while at the same time keeping default risk in check.
What's more appealing?
As you can see, there are lots of ways to gain direct exposure to the fintech sector. Investors who prioritize safety and thus want less risky options can look at Visa and Mastercard. On the other hand, for those interested in greater growth potential, albeit with more uncertainty, then Lemonade and Upstart could be exactly what you're looking for.
One thing is for certain: The fintech space is only going to keep growing in the decade ahead. Investors have myriad choices of how to allocate capital behind this secular trend.
