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Better Buy: Square vs. American Express

Matthew Cochrane, The Motley Fool

One of the hottest segments in the stock market over the past several years has been the payments industry. Over the trailing one- and three-year periods, the Pure Funds ISE Mobile Payments ETF (NYSEMKT: IPAY), an ETF that closely mirrors the payments industry, has more than doubled the S&P 500 index's gains. Two of this ETF's top holdings, companies that might be of particular interest to investors interested in this hot sector, are Square Inc (NYSE: SQ) and the American Express Company (NYSE: AXP). Let's take a closer look at each of these companies to see which might make for a better investment today.

Two brightly colored Post-It notes lying next to each other that each read "WIN."

Both American Express and Square stand a good chance of outperforming the S&P 500 in the coming years. Image source: Getty Images.

The case for Square

One decade ago, Square was founded by introducing a simple dongle that could be plugged into a mobile device that allowed small- and medium-sized businesses to accept card and digital payments at the point of sale. If Square's innovation had stopped here, the company would have been stuck offering a commoditized service (payment processing) with an innovative solution that was soon copied by competitors. Fortunately for investors, the innovation did not stop, and Square has gone on to shake up the entire payments industry.

Consider, just since the beginning of 2019, Square has:

  • Introduced an in-app payments software development kit (SDK) that allows merchants and developers to process payments using Square in their own apps.
  • Launched a business debit card, giving sellers real-time access to their money after a sale.
  • Rolled out a new online store, one that integrates Weebly's website-building technology into its online payment processing tools.
  • Partnered with the Washington Nationals to create an app that allows baseball fans to order their concessions from their seats and be notified when they're ready for pickup.

Collectively, these innovations build out a sticky ecosystem, one that sellers will find hard to leave once they subscribe to the variety of innovative services beyond Square's basic payment processing services.

These extra services and offerings are accounted for in Square's subscription and services-based revenue segment, which grew to $194 million in the fourth quarter, an incredible 144% increase over last year's fourth quarter. This segment drove Square's adjusted revenue growth in the quarter, which rose to $464 million, a 64% increase year over year. Of course, this type of explosive growth doesn't come cheap. Based on the company's forward adjusted revenue guidance of $2.25 billion, the company sells at a forward price-to-sales ratio of about 14.

The case for American Express

American Express is one of only two major U.S. credit card companies -- Discover Financial being the other one -- that directly lends to its account holders. Mastercard and Visa Inc provide the payment networks for third-party banks and financial institutions to lend to their account holders. The advantage of this aspect of Amex's business model is that it gets to collect all the payments for itself on the high-interest credit card loans it offers. The bad news is that Amex is also on the hook for that credit liability, a distinct concern, especially during economic downturns.

The good news is that American Express has a well-deserved reputation for being the best lender in the business, only approving prime borrowers, or consumers with high credit scores. This reputation is more than backed up by the numbers. In Q4, the company's lending net write-off rate -- essentially the percentage of past-due loans that the company does not believe it will ever collect -- was only 2%, an incredibly low number. Even more impressive is that Amex kept the write-off rate this low while growing its loan portfolio to $85.7 billion, a 13% increase year over year.

In American Express's fourth quarter, revenue rose to $10.5 billion, a 10% increase year over year, and adjusted earnings per share grew to $1.74, an 11% increase year over year. Based on the midpoint of its 2019 full-year guidance of $8.10, shares currently trade at a forward P/E ratio of about 13.5, a more than reasonable valuation for a company projecting to grow earnings per share (EPS) at double-digit rates. The company also reduced it share count by 3% and raised its dividend by 11% in 2018, trends that are both expected to continue.

The right pick for you

These stocks will likely appeal to different investors. Value investors looking for a stock trading at a reasonable valuation that pays a decent yield will probably find a lot to like in American Express. Investors looking for a stock with a long runway ahead of it and an accelerating growth rate will undoubtedly be attracted to Square. While I would not be surprised in the least if both companies end up beating the S&P 500 index in the years ahead, in my own personal portfolio I have invested in Square and believe it will prove to be a better investment over time.

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Matthew Cochrane owns shares of Mastercard and Square. The Motley Fool owns shares of and recommends Mastercard, Square, and Visa. The Motley Fool has a disclosure policy.