The Best Fintech Stock to Buy in 2023

One of the most exciting secular growth trends that investors should be aware of if they aren’t already is the adoption of fintech and digital payments companies. The big traditional banks were too slow to incorporate technology to improve the user experience to avoid disruption. And now many companies are encroaching on their territory.

One like that fintech pioneer, Block (SQ -0.03%)should be on every investor’s radar right now. JPMorgan Chase CEO Jamie Dimon even said that the business, formerly known as Square, “innovated where we should have.”

Here’s why I think it deserves a closer look as a potential portfolio addition in 2023.

Two emerging ecosystems

What makes Block an impressive business is that it has two outstanding segments. The Square unit provides financial services, software and hardware solutions to small retailers looking to seamlessly accept card payments from customers, as well as manage payroll, invoicing and loyalty programs, among many other services. During the most recent quarter (Q3 2022 ended September 30), Square’s gross profit increased 29% year-over-year. And the segment processed gross payment volume of $50 billion, which was up 20% year over year.

There’s also Cash App, the popular personal finance mobile app aimed at individuals, which was the No. 2 ranked financial app on apple App Store, back only Intuitits TurboTax. Cash App allows users to buy stocks, trade Bitcoinsend and receive peer-to-peer payments and get debit cards.

Cash App, like Square, is posting amazing growth. Segment gross profit of $774 million represented a 51% year-over-year increase. And last September, Cash App counted 49 million monthly active users, with 18 million active Cash App Card customers.

These two ecosystems would be great companies on their own, but Block is finding ways to strengthen the ties between them. Cash App Pay allows customers to make purchases at Square merchants directly with their Cash App balances using a QR code. And with the addition of buy now, pay later specialist Afterpay, Cash App customers and Square merchants are further integrated thanks to the payment service.

Big upside

Block’s past growth has been tremendous, but there is still significant opportunity ahead. According to the management team, the company has a gross profit opportunity of $120 billion, an opportunity that continues to grow. As it continues to expand its product offerings while entering existing regions and entering new ones, Block’s story is far from over.

Another upside is the resurgence of Bitcoin, which is up 38% so far in 2023. If peak cryptocurrency momentum continues, it could be a boon for Cash App in terms of attracting new users and getting their existing ones to add more money to the platform to buy Bitcoin.

Despite general macroeconomic weakness, Square and Cash App continue to demonstrate that they can grow in this environment. And with $7.1 billion in cash, compared to long-term debt of $4.6 billion, shareholders have confidence that the business will weather any short-term recession.

The beauty of payment companies is that they can be extremely lucrative on a large scale. For example, just look at the two dominant card networks, Visa and MasterCard. These giants have pristine income statements. Visa and Mastercard’s net income margins were 51% and 43%, respectively, in their last fiscal quarter.

And so it is PayPalwhich has experienced a slight decline in recent quarters, but still generated free cash flow of $1.8 billion in the third quarter of 2022 with revenue of $6.9 billion. That equates to an incredible margin of 26%.

To be clear, with its Square and Cash App segments, Block obviously doesn’t have exactly the same business model as Visa, Mastercard or PayPal. However, Block benefits from operating leverage. The marginal cost of processing each additional transaction for its merchant base or its individual users is negligible because the network infrastructure is already largely built out. Therefore, as revenues and gross profit continue to climb in the years ahead, Block’s margins will increase and the hope is that it will be very profitable.

With a price-to-sales multiple of 2.5 today, investors should not hesitate to add this amazing company to their portfolios in 2023.