The digital payments industry has many catalysts for growth in both pre and post pandemic. The ETFMG Prime Mobile Payments ETF (IPAY) gives exposure to innovative companies in this sector and is my recommended ETF for this purpose.
Digital Payment Market Growth
Prior to the COVID pandemic, digital payments were already growing significantly, as more and more people turned to the convenience of online shopping. For in-person transactions, cash is cumbersome and a pain to carry at times, and so digital payment methods such as Apple (AAPL) Pay are growing quickly. The allure of fast peer-to-peer (P2P) payments to settle personal transactions rather than dealing with cash or mailing a check has driven increased adoption of payment methods such as PayPal (PYPL), Venmo, and Square’s (SQ) CashApp. Cash is trash, in more ways than just inflation.
The digital payments market is expected to continue to accelerate with the pandemic spurring more growth, especially in digital point-of-service (POS) transactions. The e-commerce market is expected to grow 20% in 2020 while in-person department store transactions are expected to decline significantly. In addition, due to the pandemic, people are moving away from using cash as it increases the amount of surface area to spread germs. Instead, more consumers and businesses are opting for contactless digital payments to reduce the risk of spreading COVID-19. Nearly 50% of global shoppers say they are using digital payments more than before the pandemic.
Prior to the pandemic, many households were prevented from participating in digital payments due to financial (lack of bank accounts) and digital (lack of internet access and/or understanding) barriers, as the Kansas Federal Reserve Bank notes. The pandemic has catalyzed both private and public efforts to remove those barriers through policies and legislation. As our technological infrastructure continues to improve, we should see increased access to digital payments for a higher percentage of the population.
IPAY – ETFMG Prime Mobile Payments ETF
I personally choose to invest in the IPAY ETF to invest in this sector. Its expense ratio is pricey at around 0.75% but that is typical of more actively managed ETFs. It is difficult to find an alternative, low-cost and passive ETF because I want to specifically target companies in the financial services sector that are technologically focused and innovative. A financial services sector ETF like XLF doesn’t choose tech focused companies. The NASDAQ-100 tech focused ETF QQQ doesn’t focus on financial services.
The top holdings of IPAY resonate with me and are stocks I would definitely hold individually. It’s likely cheaper to purchase those stocks and replicate the ETF rather than pay the expense ratio. However, I would lose the benefit of diversification, rebalancing, and management. Additionally, if a broker does not support fractional shares well, it is difficult to purchase individual components affordably.
The current top holding of IPAY is Square which a company I also hold individually as I strongly believe in the company. It is a perfect mix of exposure to the digital payments industry in both business and P2P transactions as well as technological innovation.
It has been able to penetrate the small business market because its technology gives businesses an end-to-end payments solution, both software and hardware, from accepting payments to inventory management to business analytics with lower overhead costs and is very easy to setup.
In its 2020Q2 shareholder letter, it shows that its CashApp business (P2P) grew 361% in revenue and 167% in gross profit YoY. Its seller ecosystem (business POS) fell 17% for revenue and 9% for gross profit YoY due to the pandemic and its large exposure to small businesses. However, it notes that every month in Q2 saw increases in sales volume and transactions as lockdown orders were lifted. It expects the positive trend to continue from July onwards.
Paypal provides similar offerings as Square and also benefits from a shift to digital payments. It has Venmo for its P2P segment and its core Paypal offering facilitates tons of online transactions for smaller businesses. For Q2 2020, it reported record growth in both its business and P2P segments transactions. Revenue increased 25% YoY and earnings increased 48% YoY. It also raised its third quarter guidance based on this growth.
Visa and Mastercard
These two industry giants dominate 90% of the debit and credit card transactions market. Though Square, Paypal, and other digital payment tech companies are growing quickly, most of the transactions that go through their systems are linked to credit and debit cards issued by Visa and Mastercard, meaning Visa and Mastercard also benefit as digital payment transactions grow, even if consumers aren’t physically swiping cards anymore. For example, Square’s Cash Card debit card is issued by Visa. Their main competitors, cash and ACH transactions, will decline due to the effects of the pandemic.
The two companies did face headwinds in 2020 Q2 due to decline in consumer purchases. However, as the Square shareholder letter suggests, based on increase in transactions in their seller ecosystem, consumer confidence is slowly returning and these companies stand to benefit. The consumer confidence index in OECD countries also reflect a slow return.
Additionally, these two companies are positioning themselves for the digital payment growth. As noted by Mastercard CEO, Michael Meibach, “We are providing digital-first solutions that leverage our tokenization and other digital technologies to meet these changing needs.” Visa also acknowledges the importance of this growth and is continuing to improve its technology to meet the demands of digital payments.
While the pandemic is causing a shift from cash to digital payments, there is still inherent risk from the weak economy. Consumers could simply consume less in general which means both cash AND digital payments decline. With the extended unemployment benefits expiring in July and no second stimulus bill is sight as of the publication of this article, the consumer market is likely in for some pain.
Despite this, I still believe that in the long term we will recover from the fallout of the pandemic eventually. Dr. Fauci believes we will return to normal eventually, but likely not until the end of 2021. In the meantime, the business outlooks from the top holdings of IPAY are cautiously optimistic even during the pandemic and are certainly not near bankruptcy risk like companies in the hospitality, travel, and entertainment industry.
If you choose to invest, be prepared to hold long term (> 5 years) and ride out the volatility caused by the pandemic. I choose to invest now as I believe the price will only get more expensive if and when vaccines are announced to be safe and begin distribution. I also recommend continually monitoring the performance of the top holdings to check that they are still growing and thriving in the current environment.
Disclosure: I am/we are long IPAY, SQ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am not a financial advisor. All recommendations here are purely my own opinion and is intended for a general audience. Please perform your own due diligence and research for your specific financial circumstances before making an investment decision.