Fintech is the application of technology to financial businesses or processes. Of course, this encompasses a wide variety of categories. We already see pieces of it in everyday life whether it’s paying by using an app, using a credit card reader at a store, or depositing a check by taking a picture of it.

In the same way that the Internet disrupted how information and content are shared and created. Experts believe that how money is exchanged, earned, spent, saved, and invested will also be disrupted, and we are only in the early stages of this transformation.

We can look at Asia to get a preview of how fintech will change consumer behavior in the US. People in Asia are ahead of the US in terms of using fintech to manage their finances and make payments through apps like WeChat Pay or AliPay. In China, 80% of people have used mobile payments, while in the US, it’s 10%, although the coronavirus is leading to an uptick in adoption.

(source: IMF)

The chart above shows how mobile payments have exploded in China to above 2.5x that of GDP. Currently, in the US, mobile payment transactions are at about 25% of GDP but growing at a similar rate to China’s a few years ago.

This is evident in the chart below which shows the growth of digital wallets:

(source: TSYS US Consumer Payment Study)

Interestingly, growth in digital wallets exceeds growth in social media use which was the last major trend that has had massive impacts on how people spend their time, socialize, and connect with family and friends.

(source: TSYS US Consumer Payment Study)

Digital wallets and social networks both grow in utility and leverage as more users join the app. In turn, as more users join, more features and capabilities are built on top of the network which also attracts more users. This results in a powerful business that essentially becomes an ecosystem with its own self-sustaining ecosystem.

And, just like social media companies like Facebook (FB), Twitter (TWTR), Pinterest (PINS), and Snap (SNAP) have created nearly a trillion dollars in shareholder value, fintech companies will likely do the same.

Bright Prospects for Q4 and Beyond

Investors are always hungry for growth. This is one of the few parts of the economy that is meaningfully large and growing at an above-average rate with the coronavirus leading to an acceleration in growth rates and a rapid increase in adoption.

(Source: Ark Investment Management)

So, it’s not surprising that fintech stocks have been among the biggest outperformers of the year. The chart above shows that fintech adoption is about to exponentially increase at a 27% CAGR over the next few years.

While this above-average growth rate is fuel for the sector’s long-term outperformance, the sector is also setting up to breakout on a short-term basis which boded well for its prospects in the fourth quarter.

Since the March bottom, both fintech stocks, as measured by the ARK Fintech Innovation ETF (ARKF), and the Nasdaq have gained 117% and 73%, respectively. What’s even more interesting is that since early September, the Nasdaq has been range-bound, while fintech stocks continue to maintain their pattern of higher highs and higher lows.

This is an indication of continued accumulation in these stocks and that if the market resumes its ascent, fintech stocks are likely to keep leading. Investors should consider using the current market dip as an opportunity to add fintech exposure to their portfolios. Four of the best fintech stocks are Paypal (PYPL), Square (SQ), MercadoLibre (MELI), and Fiserv (FISV).

Paypal (PYPL)

PYPL is a spinoff from eBay (EBAY), and it’s almost six times as big as its parent company. In essence, PYPL has created a lot of financial plumbing which made online business possible. The company acts as an intermediary between buyers and sellers to make online transactions trusted and seamless. Through this, it’s grown into numerous, adjacent areas of business including digital wallets, payments, and helping online sellers increase conversions and profits.

In recent years, it’s gotten into lending and analytics as well which are higher-margin. PYPL’s success also exemplifies why digital wallets are a great business, because it becomes a platform from which companies can offer other products and services to their customers. For example, Alipay lets its users do banking, insurance, investing, lending, and shopping straight from the app.

In recent days, PYPL’s stock has been threatening a breakout to new highs. It rallied 5% on news that it was offering cryptocurrency trading to customers. This should result in user growth and be another revenue source for the company in the coming years as cryptocurrencies continue to gain steam.

In terms of its financials, PYPL expects to grow its earnings from $1.58 this year to $4.13 next year and forecasts 15% annual earnings growth over the next 5 years. All the same while, it should continue to add users, offer them more services, and move into more high-margin areas.

PYPL’s POWR Ratings are bullish as well as it’s rated a Strong Buy. It has an “A” for Trade Grade, Buy & Hold Grade, and Industry Rank with a “B” for Peer Grade. Among Consumer Financial stocks, it’s ranked #5 out of 46.

Square (SQ)

SQ has been one of the best-performing stocks of the year. The pandemic hurt many of its small business customers who use their readers to process payments, however, it was able to more than make up for this with increased online sales, and more users signing up for its service.

Square’s Cash App has 30 million users, $1.2 billion in revenue, and earned $281 million in profit during its last quarter. It lags Paypal in users but has a faster pace of growth. It’s also seeing a large surge in bitcoin orders and this is another way the company can get more user growth.

The company is the fastest-growing in terms of digital wallet usage in the US. The coronavirus led to a surge in new users with the use of cashless transactions and mobile payments soaring. It’s also expanded into banking by getting FDIC approval. At first, it plans to offer small business loans and consumer financial products. Given that its users skew young, Square has an opportunity to become the platform by which many Gen Z and Millennials buy insurance, wealth management, and other financial services and products.

SQ is rated a Buy by the POWR Ratings. It has an “A” for Trade Grade, Peer Grade, and Industry Rank with a “B” for Buy & Hold Grade. Among the Enterprise Financial Services sector, it’s ranked #2 out of 232.

MercadoLibre (MELI)

Similar to how Alibaba created AliPay to improve its eCommerce business by having a trusted intermediary to handle payments, MELI developed a fintech solution to support its eCommerce business. Like SQ, it’s for the small businesses that sell on its platform and consumers to do their banking, payments, etc.

When EBAY owned PYPL, it also owned a portion of MELI. And, it helped MELI build its fintech product – Mercado Pago which was modeled after PYPL. So, it’s not surprising that Mercado Pago is doing very well with some structural advantages to PYPL – less competition and a more underbanked, younger population.

MELI has been a consistent winner with one of the biggest gains in the last bull market. And, it’s continued with a 188% gain off the March lows. The stock is also rated a Strong Buy by the POWER Ratings with an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade with “B” for Industry Rank. It’s ranked 12th out of 58 Internet stocks.

Fiserv (FISV)

FISV is more of a stealth fintech stock. It offers electronic payment processing, retail point of sales, and eCommerce services to its customers. It also operates Zelle which is used by banks for digital payments, so this is a potential tailwind for the stock.

It’s also much more reasonably priced than SQ or PYPL with a forward P/E of 19. To compare, SQ and PYPL’s forward P/E are 146 and 45, respectively. However given FISV’s heavier dependence on retail sales, it’s been more affected by the pandemic.

Thus, it could continue to underperform in the near-term but outperform, when retail sales bounce back when the world gets back to normal. This also lines up with the rotation from growth to value which seems likely to happen when health risks recede and the economy returns to normal. As a result, long-term rates would move higher, leading to a squeeze in oversold, value stocks, and multiple compression in growth stocks.

So, FISV could give investors fintech exposure with less downside if this hypothesis plays out. Even during the pandemic, FISV’s business has growth opportunities helping its users transition to online sales.

Conclusion

Fintech should be on every investors’ radar due to its rapid adoption and massive potential. There’s already evidence of this with AliPay which has 1.3 billion users and generated $10.5 billion in the first half of 2020. This was a 30% increase from the first half of 2019.

All four of these stocks have huge user bases and are adding more. The lesson from these types of platform-stocks is that companies get better and better at monetizing users. While social media has become wildly lucrative just from targeting ads based on user information, fintech companies have more monetization opportunities since these platforms are used to make financial decisions. This is already borne out by the results of these companies. The products are incredibly sticky as well. Uses are unlikely to switch, once they start using it consistently.

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PYPL shares were trading at $202.37 per share on Friday afternoon, down $1.56 (-0.76%). Year-to-date, PYPL has gained 87.09%, versus a 8.47% rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...

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