Financial technology -- from digital payment processing to online banking -- is nothing new, but the fintech industry has gained serious momentum in the past decade. Added convenience, new features, and shifting consumer preferences are causing the fast rise of e-commerce, and, along with it, digital money management. Many stocks in the industry are earning triple-digit-percentage returns.
Many fintech stocks might seem expensive, especially after some of the industry's biggest names have rallied over the past several years. Here's some guidance to help you decide if now is a good time to add fintech stocks to your portfolio.
When to buy fintech stocks
The short answer is that any time is a good time to buy excellent fintech stocks.
Why? Because trying to time the market is generally a losing battle, and that's especially true when it comes to predicting the fortunes of rapidly growing companies. How many people thought that Amazon (NASDAQ:AMZN) was too expensive when its stock price first hit $1,000, only to miss out owning a stock whose price has since tripled? Attempting to "wait for a better price" is a faulty strategy.
While a company's valuation and performance should certainly be considered, fintech investors should not overly rely on traditional valuation metrics, which may make most fintech stocks look "too expensive." One important lesson that many investors (myself included) have learned the hard way is that growth potential always gets priced in, making that "expensive" stock potentially well worth it.
Let's take fintech-enabled payment processor Square (NYSE:SQ) as an example. As of February 2021, Square stock trades for 506 times the company's trailing-12-month (TTM) earnings and 14 times TTM sales -- lofty valuation metrics by any definition. However, when you consider that Square's revenue for its most recent quarter grew by a staggering 140% year over year, the high valuations could certainly be justified. Square stock may even be cheap from a long-term perspective.
To decide which fintech stocks to purchase, focus on innovative companies with durable competitive advantages and excellent management teams. Don't focus just on valuation. But if you think that a particular fintech stock might be too expensive, then you might want to apply the concept of dollar-cost averaging (investing incrementally over time at prevailing market prices) to build your position gradually.
You can also consider reviewing the principles of growth stock investing before you choose which fintech stocks to buy.
When to buy fintech ETFs
If you want to profit from innovation in financial technology but don't want your portfolio's performance to be too heavily influenced by the fortunes of any single company, then investing in one or more fintech exchange-traded funds (ETFs) could be better for you.
There's no question that the fintech sector is growing rapidly and that the space has some exciting investment opportunities. Investors are attracted to ETFs, fintech-focused and otherwise, because they enable you to put your money to work in a basket of stocks with just a single investment.
Here are a few examples of ETFs in the fintech space:
1. The Global X FinTech ETF (NASDAQ:FINX) is the oldest fintech ETF. The fund allocates its money among 39 different fintech stocks, with top holdings including Square, Afterpay (OTC:AFTP.F), PayPal (NASDAQ:PYPL), and StoneCo (NASDAQ:STNE), just to name a few. And while its 0.68% expense ratio (denoting how much of an annual fee the fund's managers collect) isn't exactly cheap, it's on par with those of other actively managed growth ETFs.
2. The ETFMG Prime Mobile Payments ETF (NYSEMKT:IPAY) has a slightly higher expense ratio -- 0.75% -- and specifically targets the mobile payments segment of fintech. The ETF holds 44 different stocks, with the most concentration in Square, PayPal, Mastercard (NYSE:MA), Visa (NYSE:V), and American Express (NYSE:AXP).
3. The ARK Fintech Innovation ETF (NYSEMKT:ARKF), which charges investors a 0.75% expense ratio, focuses on fintech stocks but takes a somewhat different approach than the other ETFs mentioned. Specifically with top holdings that include Zillow (NASDAQ:Z) (NASDAQ:ZG), Tencent (OTC:TCEHY), and Pinterest (NYSE:PINS), in addition to some of the more traditional fintech stocks, the ARK ETF invests not just in companies typically considered to be pure fintechs. It also focuses on those that could greatly benefit from financial technology.
Risks of investing in fintech stocks
No high-growth stocks are without risk, and fintechs are certainly no exception to this rule.
For one thing, although fintech stocks mostly did well during the COVID-19 pandemic due to the surge in e-commerce and growing popularity of contactless payment methods, fintech stocks could prove quite cyclical if a "typical" recession were to commence. Most fintech businesses depend on consumers and businesses being willing and able to spend money, which can decline rapidly in uncertain times.
There's also a ton of competition in the fintech space, which can make it hard to determine which specific companies will preserve or expand their market shares going forward. And, fintech stocks can be incredibly volatile, even when the stock market and the underlying business are both performing well.
Fintech is one of the biggest growth markets of the 21st century, and it can be a great sector for long-term investors to put their money to work. Conduct due diligence before investing in any specific fintech stock, but remember that it's never a bad time to add the stocks of well-run, innovative companies to your portfolio.