If You Like Apple Pay, You'll Love the Potential for These Stocks

By Markets Fool.com

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In September, Apple made waves with the introduction of Apple Pay.

Apple Pay is a new product, and as such Apple doesn't yet break out revenue or profitability numbers specific to it. But early reports from industry groups point to a strong start. One reported estimated that Apple Pay achieved a 1.7% U.S. market share of mobile payments after just six weeks on the market. That's incredible. Over 750 banks currently offer Apple Pay with their accounts, and Apple Pay represents 40% of contactless payment volume as of this month.

The digital payments industry is pretty complex and interconnected, and with Apple's entrance into the fray there are certainly other companies that stand to benefit from the growth of Apple Pay. If you think Apple Pay will be the next big thing, read on to learn how digital payments work and determine which companies could benefit the most.

A quick primer on how digital payments work
When you pull out your card and swipe to make a purchase, that card is linked to either the cash in your bank account or the available funds tied to your credit card. On the other end of the transfer is the merchant's bank. The objective is to accurately and securely move the money from your account to the merchant's account.

That transfer is facilitated by a company known as a payment processor. Visa and MasterCardare far and away the largest of these companies. Payment processors operate similarly to a toll collector on a highway. When you make a purchase, they collect a small fee based on the transaction. These companies are not necessarily banks, even though their logos appear on your credit or debit card. That logo just represents which highway your digital payment will travel.

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The process is obviously more complex than this, but for our purposes, this explanation is sufficient. For a complete explanation of how digital payments work, click here.

What Apple Pay is and what it isn't
So where does Apple Pay fit into the process? Apple Pay is, effectively, a way to swipe your card without actually swiping your card. The same banks are involved, and the same payment processing networks act as the highways for the money to transfer.

Apple Pay makes transactions more convenient. The information from your plastic cards is stored in your Apple Pay account, and using a technology known as near-field communication, the iPhone transmits that card data to a receiver. That receiver sends the information on to the existing payment networks.

The payment processors still make money the way they always have, while Apple gets a small fee on every transaction, paid by your bank. The bank still makes money off your deposit or credit account, less the small fee paid to Apple.

As a business model, there really isn't anything wildly innovative about Apple Pay. Apple is edging in on some of the banking industry's $40 billion in transaction fees. That could prove to be a nice income stream for Apple, but it's not a major disruption to the industrywide status quo.

In my view, the biggest industry impact from Apple Pay will be wider use of the digital payment system. If that's true and transaction volumes increase, then some major players stand to benefit from Apple's entry to the market.

So who stands to benefit from Apple Pay?
Although Apple Pay gives Apple a piece of the transaction-fee pie, I think banks will still benefit most.Apple doesn't want to be a bank; banks have strict regulations, operate with high leverage to meet profitability targets, and don't produce nearly the same returns on assets or equity that Apple does.

That's why Apple Pay isn't an existential threat to banks such as JPMorgan Chase and Bank of America , the two largest credit card issuers in the United States. Rather than being adversarial, the relationship is symbiotic.

Apple Pay's convenience and security could encourage consumers to put their existing accounts to more use. It could mean those accounts might carry higher balances and also produce more transaction fees as consumers use their iPhones to pay electronically instead of using cash. That growth, in my view, will easily outweigh the small fees paid to Apple for every Apple Pay transaction.

The digital payment superhighways
The same logic applies to the payment processing networks.Building and operating a new payment processing network, at scale, would take an incredible amount of financial and intellectual diplomatic capital. For Apple, that effort just isn't worth it, particularly when there's a pre-existing network of payment processors that do a pretty great job already. Why reinvent the wheel?

For Visa and MasterCard, Apple Pay is a slam dunk. The more transactions that go across their network, the more they get paid. It's a win-win.

The two companies that can double-dip
American ExpressandDiscover Financial Services sit in a unique position in the digital payment world. These companies operate both as banks and as payment processors.

With increasing mainstream use of mobile payments, the traffic on their payment network would increase, simultaneously encouraging customers to use their lines of credit and checking accounts on the bank side.

The key for all is driving mainstream adoption of mobile payments
The hope for Apple and all the other companies mentioned here is that Apple Pay and the iPhone will drive digital payment volumes higher.

Apple is a trend-setter, and in an emerging technology like mobile payments, having the support of an industry leader can be the difference between adoption and obsolescence. With the rollout and early success of Apple Pay, the future is bright for mobile payments and all the companies that make money when we pay digitally.

The article If You Like Apple Pay, You'll Love the Potential for These Stocks originally appeared on Fool.com.

Jay Jenkins has no position in any stocks mentioned. The Motley Fool recommends American Express, Apple, Bank of America, MasterCard, and Visa. The Motley Fool owns shares of Apple, Bank of America, Discover Financial Services, JPMorgan Chase, MasterCard, and Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.