3 Fintech stocks that could beat the market in the next 5 years

2022 has been a reminder that market-beating stocks don’t have to be the highest and riskiest bets. Sure, I’m a fan of sprinkling some moon shots into my portfolio. But companies that produce consistent and profitable growth are the best long-term investments.

With interest rates on the rise and monetary policy in the Fed tightening, the financial industry and the technology industry have been particularly hard hit. But not all fintech stocks are created equal. FactSet Research Systems (FDS -0.24%), Nasdaq (NDAQ 0.59%)and PayPal Holdings (PYPL -5.65%) are three potential market beaters in the next five years. Here’s why.

1. FactSet Research: The stable software provider hiding in fintech clothing

FactSet is not an often-followed name among fintech stocks, but I think it should be. Now in its fifth decade, the company has provided financial services clients with critical information about industries and markets since 1978. The company boasted its 41st consecutive year of revenue growth in 2021.

This statistic alone is impressive, but this research software provider’s long-term profitability growth is *what’s really impressive. Since the IPO in 1996, free cash flow per share (the calculation we will use for all three shares here) has risen over 5,000%. That’s the real secret ingredient that has made FactSet a consistent market performer for years—including over the past one-, five-, and 10-year periods.

Data from YCharts.

FactSet continues to deliver on this metric. Although organic annual subscription value growth (which excludes the impact of acquisitions on the value of customer software subscriptions) grew “only” 10% year over year last quarter, total revenue was up 22%. That was thanks to two financial software peer acquisitions last year (Cobalt Software and CUSIP Global). But thanks to FactSet’s ability to unlock the value of bolt-on services, adjusted operating profit was up nearly 42% year over year.

With data only increasing in importance for organizations of all types, FactSet’s tools designed to increase understanding of industries and their financial makeup should continue to gradually expand for years to come. The company is also using excess cash to buy back shares and pay a modest dividend. The shares currently trade for 30 times trailing 12-month free cash flow. That’s not an unreasonable price if you believe that FactSet’s two new acquisitions will keep its bottom line rising rapidly for at least the next couple of quarters — and for the business overall to continue growing at a steady pace for the foreseeable future.

2. Nasdaq: It’s a stock exchange, it’s a stock index, it’s a business!

The Nasdaq stock exchange (where many technology and fintech companies list their shares for public trading) and Nasdaq Composite Indexes (one of a few common collections of stocks we use as benchmarks every day) are familiar features of the investment world. The company responsible for both – Nasdaq Inc. – is itself a stock worth getting to know.

Like FactSet, Nasdaq has been around for a very long time, founded in 1971 and making its debut as a listed company in 2002. Today, Nasdaq is the owner of several stock and asset exchanges in the US and Europe. Since asset prices tend to rise over time, Nasdaq has seen gradual growth for years (since it earns transaction and listing fees from market participants based on overall asset values).

It’s a classic toll booth-like business model, and the consolidation of various exchanges over the years has certainly helped. Nasdaq’s free cash flow per share has risen nearly 4,000% since 2002, helping the company outperform the market overall.

Exchange services will remain a critical component of the global economy as companies use investors for capital and investors buy companies to increase their wealth. But in recent years, Nasdaq has begun to transition from a traditional transaction-based model to more subscription software services. Offerings include markets and finance data, as well as environmental, social and governance (ESG) solutions for organizations looking to update their operations to meet corporate concerns.

Revenue rose just 6% year-over-year last quarter, but adjusted earnings rose 9%. Another frequent share buyback, Nasdaq could continue to beat the market over the next few years thanks to its highly profitable operation and transition to software solutions.

3. PayPal: Online payment provider built to last

I prefaced PayPal with a discussion of FactSet and Nasdaq because of what I hope PayPal will one day become in the fintech space: Steady growth that makes judicious use of profitability to increase shareholder value. While FactSet and Nasdaq have both been market-beating investments (including the past year during the 2022 bear market), PayPal has been anything but. The online means of payment has fallen 73% in value over the past 12 months.

PayPal’s management didn’t do a good job of broadcasting the big slowdown in e-commerce spending from early in the pandemic. Hopes were high heading into 2022, with management forecasting at least a 19% year-over-year increase in total payment volume growth. But rapidly changing consumer spending driven by inflation and rising interest rates quickly changed that outlook. In the first quarter of 2022, guidance was downgraded for total payment volume to expand just 13% to 15%.

Despite falling growth expectations, PayPal (and its Venmo app-based money tool) remains in good shape. Tens of millions of consumers and businesses rely on their collection of digital payment tools every day. And the company generated $4.95 billion in free cash flow last year, a healthy margin of 19%. The site was separated from the previous e-commerce site eBay in 2015, free cash flow per share increased by almost 2,800%.

PayPal’s days of rapid growth may be over, but there could be many more years of more modest and profitable expansion as app-based money management and payments aren’t going anywhere. The balance is also in top form. Cash and short-term investments totaled $7.97 billion, long-term investments were $7.15 billion, and debt was $8.22 billion at the end of March. Eventually, I expect PayPal to begin returning excess cash to shareholders with share buybacks — perhaps even a dividend one day — a template for success that has driven FactSet and Nasdaq to beat stocks for decades. Trading for just 19 times trailing 12 months of free cash flow, PayPal looks set to beat the market over the next five years.