Many investors think of the major credit card brands as similar companies, but this isn't the case. Payment processors such as Mastercard (NYSE: MA) have a business model that is significantly different than credit card issuers like American Express (NYSE: AXP). Here's a rundown of the similarities and differences between these two companies' business models and which could be the better buy now.
Payment processors versus credit card issuers
Continue Reading Below
Mastercard's primary business model is payment processing. The company doesn't itself issue credit cards -- instead, it serves as a middleman between consumers, businesses, and banks. A consumer swipes a credit card at a business, and the bank that issued the credit card sends a payment to the business. Mastercard's payment network facilitates these transactions. It makes most of its money from "swipe fees," which are charged to merchants when a customer pays with a Mastercard-branded credit or debit card.
On the other hand, American Express is a "closed-loop" payment network. Put another way, American Express is both the middleman and the bank. When an American Express card is swiped, American Express is the lender that sends money to the merchant and bills the consumer.
Because of this, not only does American Express make money from swipe fees, but it also earns interest income from outstanding consumer balances, as well as fee income from the annual fees charged to cardholders.
Growth and future potential
Mastercard has delivered pretty impressive growth numbers recently. Its third-quarter results showed a 18% revenue increase and a 24% rise in EPS over the past year on impressive growth in transaction volume. The company also has several pathways to future growth, such as in its overseas business and with new payments technologies, in which it has invested heavily in recent years.
American Express, on the other hand, has done an excellent job of getting past the loss of its Costco partnership, although its growth hasn't been quite as impressive as Mastercard's. Revenue grew at 9%, half the rate of Mastercard, although EPS grew by 25%.
However, there is just as much long-term growth potential as Mastercard has, especially if the company decides to aggressively pursue international markets. Visa and Mastercard are widely accepted in many international markets, while American Express is not. After all, there are more than four times as many Mastercard-branded cards than Amex cards in circulation.
Mastercard clearly has the edge when it comes to growth. However, you'll pay a significant premium for it. As you can see in the chart below, American Express is the cheaper of the two, by a significant margin.
Which is the better buy now?
Both of these companies are rock-solid payment processing giants, and I don't think investors will go wrong with either stock over the long run. Globally, electronic payments make up just over 10% of transactions, so there's no shortage of opportunity for both of these companies to grow tremendously over time.
Having said that, I would buy American Express now, and in full disclosure, I already own shares in my portfolio. At about half the valuation of Mastercard and strong long-term growth potential, I think the risk-reward simply makes more sense. And as a closed-loop payment network, American Express is in a position to expand its profits as interest rates rise. While I'm certainly a Mastercard bull, and I applaud the company's aggressive investment strategy into financial technologies, American Express looks like the better value right now.
Find out why Mastercard is one of the 10 best stocks to buy now
Motley Fool co-founders Tom and David Gardner have spent more than a decade beating the market. (In fact, the newsletter they run, Motley Fool Stock Advisor, has tripled the market!*)
Tom and David just revealed their ten top stock picks for investors to buy right now. Mastercard is on the list -- but there are nine others you may be overlooking.
*Stock Advisor returns as of November 6, 2017