The United States is the world's largest economy, and consumer spending accounts for over two-thirds of that economic activity. Americans spending money essentially makes the world's economy go round.
All that money must flow on networks connecting consumers, merchants, and banks, which many call the payments industry. Just a tiny trio dominates this space. Approximately 96% of U.S. debit and credit card payments ran on just three networks in 2022, according to research by The Motley Fool.
As you might imagine, the companies behind the networks have been stellar investments for years.
The best part? They are poised for more success; you can buy and hold stock in all three for under $1,000.
First place: Visa
Visa (V -0.23%) is the largest payment network in the United States and the world (excluding China). Approximately 71% of America's debit and prepaid card purchase volume ran on Visa's payment network in 2022, and just over half of credit card volume. Visa is like a toll booth charging a fee, a percentage of each transaction, to access its network.
When you swipe your Visa card, data runs back and forth between the point of sale and whatever financial institution is holding your money. The network authenticates and approves the transaction, which is why you see your card was approved at the payment terminal. Visa's network is established, so it doesn't need much constant investment. As people ditch cash over time, growing payment volume creates enormous profits for Visa.
V Free Cash Flow data by YCharts
The company generates $19 billion in free cash flow on $33 billion in revenue, an impressive 57% conversion rate. Management is using its billions in cash to repurchase shares and grow its dividend. Analysts believe Visa will continue growing earnings at an annual average of 15%, making the stock a no-brainer buy and forever hold for as long as it maintains its dominance in the industry.
Second place: Mastercard
Despite Visa's dominance, the payments industry is so large that Mastercard (MA 0.07%) has done remarkably well as the industry's runner-up. Mastercard powers roughly 29% and 24% of U.S. debit and credit transactions. It's also a global payments network with an estimated 28% market share, second to Visa's 47%.
Frankly, Mastercard and Visa are nearly identical businesses. Of course, they partner with different card issuers, but Mastercard has a solid footing in payments, and its business is similarly lucrative. Mastercard generates nearly $11 billion in cash flow on $25 billion in revenue. One key difference between Visa, Mastercard, and the next company is that the first two are dedicated payment networks. They don't directly issue cards or lend money.
MA Free Cash Flow data by YCharts
Mastercard follows the same formula with its vast cash flow streams -- share repurchases steadily lower outstanding shares and support earnings growth. Analysts believe Mastercard's earnings could grow by an annual average of 18% moving forward. That should translate to more robust dividend growth. Mastercard's dividend has grown by an average of 20% annually, increasing five-fold over the past decade. And yet the payout still only uses up about a fifth of Mastercard's cash flow today.
Third place: American Express
The story changes a bit with American Express (AXP -0.62%). It's both a payment network and a bank, meaning it's issuing payment cards and lending the money when consumers rack up debt on their credit cards. It's a smaller network but still owns about 13% of America's credit card market and has a single-digit percentage of the global market. Famous investor Warren Buffett has owned the stock as a top holding for decades within his holding company, Berkshire Hathaway.
American Express carries credit risk in its business as a lender, which investors should consider when buying the stock. However, American Express has been in business since the mid-1800s, navigating various economic storms throughout American history, so investors can feel good about the company's durability.
AXP Free Cash Flow data by YCharts
Importantly, management has noted in recent earnings calls that millennial and Generation Z consumers are its fastest-growing customer demographics, which bodes well for American Express' long-term future as a fixture in the consumer-spending landscape. Analysts believe earnings will compound at 14%.
Buy one? Why not all three?
These companies dominate U.S. payments, which establishes powerful network effects. In other words, merchants have little reason to use different networks because these three are accepted virtually everywhere.
Market share dynamics between them could always change, but investors could easily buy and hold all three and ride the years-long shift away from cash payments. In 2015, roughly 24% of U.S. consumers stated they no longer use cash, according to a study by Pew Research Center. By 2022, that percentage had grown to 41%.
The long-term trend is clear: These three companies will likely continue performing well as consumers move away from paying with paper currency.
