Look at the world around you, and you'll quickly notice themes happening across the economy. Investing behind these broad secular trends, like financial technology, can provide exposure to potentially winning investment ideas.
It can be a daunting task for individual investors to pick a single winner within the fintech sector, as many businesses are looking to disrupt the industry. However, I don't think this is necessary. Adopting a basket approach and buying all of the following stocks might be the smartest move.
Established players
It can be easy to focus only on the younger, more growth-oriented companies. But investors can't forget about the dominant players in the industry. I'm talking about Visa and Mastercard, which, combined, have a market capitalization of nearly $900 billion. Both stocks have crushed the broader S&P 500 over the past decade, and they are poised to do the same going forward.
These companies provide the necessary communications network that connects all the parties involved in a typical card transaction, taking a tiny fee as revenue. It's a very profitable situation. In the most recent quarter, Visa and Mastercard posted operating margins of 64% and 59%, respectively. Plus, both businesses generate ridiculous amounts of free cash flow, something you won't find at most fintech enterprises.
While they are established incumbents, I still view Visa and Mastercard as attractive companies to invest in that are at the crossroads of finance and technology. They enable cashless transactions. As economies become more digital and cash continues to dwindle in usage in different countries, Visa and Mastercard should benefit by handling higher payment volume and getting more of their cards in circulation around the world.
Both stocks are trading at price-to-earnings (P/E) ratios below their trailing-five-year averages. For such high-quality companies, these are almost no-brainer investments to make at these valuations.
Image source: Getty Images.
Specialized service providers
Investors should also look at smaller businesses that focus on a specific corner of the financial services industry. Payments remains a lucrative area for parking capital.
As a leader in digital payments, PayPal is worth a closer look. The business operates a two-sided network that processed $1.5 trillion of total payment volume in the last 12 months and has 428 million active accounts. PayPal has seen its growth slow recently, but it should benefit from the same trends as Visa and Mastercard, plus the ongoing rise of online shopping. Because the stock is trading at a ridiculously cheap P/E multiple of 16.7, the upside for investors is greater should the valuation increase and normalize.
While Block provides payment solutions, its product and service offerings are much more expansive. For merchants, the business offers invoicing and payroll tools, the ability to handle loyalty programs, and working capital loans, among many other services, through the Square segment. And for consumers, Cash App, which has 55 million monthly active users, is a viable alternative for individuals who need basic banking solutions. The company saw gross profit rise 21% in Q3. Shares are about 79% below their peak price, providing a nice entry point.
SoFi Technologies is a purely digital banking provider that is registering impressive growth, even though the macro environment isn't the most favorable. Revenue and members both jumped 27% and 47%, respectively, in the latest quarter. And maybe most encouraging, management believes the business will generate its first generally accepted accounting principles (GAAP) profit in the fourth quarter of this year, which would be a major milestone.
By buying shares in all the companies mentioned here, investors can ensure they have adequate exposure to some of the most promising businesses in the fintech space.
