PayPal (NASDAQ: PYPL) and Square (NYSE: SQ) are two of the biggest names in financial technology. Both companies provide the same value to merchants; they help them make more sales. PayPal excels in the e-commerce space while Square has built up a network of brick-and-mortar merchants. But both are increasingly moving into each other's territory.
Both stocks have performed well in 2018, but Square's 78% price increase year to date dwarf's PayPal's 13% jump in share price. After the rapid run-up in Square's stock price, investors may be wondering if it's still a buy, or if PayPal presents a better option for those interested in the fintech space. Let's take a closer look at both companies to determine which is a better buy.
Do they have a moat?
I like to invest in companies with a significant competitive advantage.
PayPal has built a two-sided network: 237 million active consumer accounts and 19 million merchant accounts. That network produces a real competitive advantage.
The network of merchants encourages users to sign up for PayPal in order to conveniently pay for goods and services at 19 million online retailers without having to provide payment information to each one. That value proposition is strengthened with the growth of mobile commerce where consumers are more likely to abandon shopping carts in favor of typing in their credit cards. PayPal's mobile-focused One Touch system, which allows customers to checkout even more quickly on mobile, ended the first quarter with 92 million active consumers and 8.6 million active merchants.
On the merchant side, PayPal gives businesses easier access to 237 million customers. PayPal boasts that it improves checkout rates 60% better than other digital wallets and 82% better than all payment types combined. On mobile, One Touch converts 47% better than non-PayPal purchases. As PayPal attracts more merchants, it helps attract more customer accounts, producing a virtuous cycle.
Square, on the other hand, takes a different approach. It doesn't require a thing from customers; they just go about using the same old payment methods they're used to. And merchants have a growing number of choices when it comes to setting up credit card readers, point-of-sale systems, and other services Square provides.
Square's value proposition is simplicity. From its pricing (a flat 2.75% cut from every swipe in the U.S.) to its hardware designs, Square makes everything as simple as possible.
But simplicity isn't a competitive advantage. Any company, even PayPal, can easily copy that model. Square's competitive advantage ultimately stems from merchants taking multiple services from Square. To that end, Square has made significant progress in the past year, developing products that encourage merchants to fully adopt the Square ecosystem.
Still, PayPal's network effect provides much greater protection against competitors than a burgeoning ecosystem.
What do the numbers say?
Both PayPal and Square experienced similar growth in total payment volume -- the main revenue driver for both companies -- in the first quarter. PayPal increased TPV 32% year over year while Square increased 31%.
But Square has managed to grow its revenue a bit faster. Square's adjusted revenue increased 51% in the first quarter, accelerating for the fourth straight quarter. Square's revenue is boosted by its ancillary products like Square Capital and Invoices, which make up a growing portion of its revenue.
PayPal, meanwhile, grew revenue 24%, eight percentage points less than its TPV growth. The slower revenue growth is due to a declining take rate, which is the percentage of each payment PayPal keeps. That's due to the rise of Venmo, PayPal's peer-to-peer payments app, which is in the very early stages of monetization. Venmo has massive potential, but it's currently a drag on revenue and earnings for PayPal.
Still, PayPal has managed to maintain strong earnings growth. PayPal's EBITDA increased 33% year over year in the first quarter, the same as Square's adjusted EBITDA growth.
A look at valuation
PayPal has a stronger competitive advantage and it's growing its core source of revenue at the same pace as Square. Despite pressure on its take rate from Venmo, PayPal's managing to grow earnings at the same rate as Square as well. If the price is right, PayPal is looking like the better buy.
PayPal stock is much cheaper than Square stock in terms of the multiples on both sales and earnings. That would certainly make it a better buy.
That said, PayPal stock isn't exactly cheap. It's trading at unprecedented valuations for the company, and it faces numerous challenges in the coming years. But if an investor is deadset on investing in fintech, PayPal is their best bet.
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