Apple (ticker: AAPL) is making inroads into financial services with its recently launched credit card, co-branded with
Goldman Sachs Group
(GS). Apple Pay is gaining traction as more consumers use their phones to pay for purchases in stores, avoiding handling cash in the pandemic. Indeed, Apple owns the platform and device that millions of people are increasingly using to send money and conduct e-commerce—making it an emerging competitor in financial services.
“I own Apple primarily because they’re becoming a large player in the payments space,” says Dave Ellison, manager of the Hennessy Large Cap Financial Fund (HLFNX), which has Apple as a top-10 holding. “Apple controls the phone and you want to buy stocks where business happens on the phone.”
Apple is one of several financial technology stocks that Ellison owns in his fund. His top 10 holdings consist almost entirely of fintech:
(PYPL), Square (SQ),
(MA), and payment-processing firm
Fidelity National Information Services
(FIS). Only one big commercial bank,
(C), makes his list.
“I like the companies that are moving money around, rather than the guys that are buying and selling money,” Ellison said in an interview, referring to banks, whose primary business is taking deposits and making loans.
Fintech stocks aren’t for the value-minded. PayPal, one of the year’s hottest stocks, trades at 42 times estimated 2021 earnings. Square, another superstar, goes for 118 times. Visa and Mastercard haven’t performed as well this year—partly because transaction volumes are down and cross-border revenues have fallen sharply—but they still fetch 32 and 38 times, respectively. Apple is at 28 times estimated 2021 profits, and Fidelity National goes for 21 times forward earnings.
But steep valuations aren’t a deal breaker for Ellison, partly because he doesn’t see better alternatives in the financial sector. While he owns shares of large commercial banks, including Citi,
Bank of America
(BAC), he calls them portfolio filler. The big banks have to worry about the credit cycle, Federal Reserve policy on interest rates, regulatory and Congressional oversight, and the yield curve, Ellison says. “If I own a PayPal or Square, I don’t have to worry about that.”
A major headwind for banks now is the Fed’s growing control over financial markets. The Fed’s balance sheet is nearly $7 trillion, up from $4.5 trillion in early 2015. And it now includes everything from mortgage-backed securities to repurchase agreements, corporate bonds, exchange-traded funds, and assets held through its Main Street Lending Program.
Banks are directly affected by the size of the Fed’s balance sheet, rate decisions, asset purchases, and other policy actions. With rates being held at record lows, bank lending margins are being compressed. Banks are also reluctant to lend to consumers and businesses, partly because the U.S. could be entering a downturn in the credit cycle, pressuring the value of mortgage loans and other assets on their books.
“The banks are all in the same bucket, making loans, taking deposits on the margins, there’s no difference with them, and there are so many of the stocks that it dilutes the real benefit of owning the stocks,” Ellison says.
Fintech stocks aren’t immune to these issues, but they are far less directly affected, acting as the conduits and rails of the system. The stocks benefit from scarcity value and the tailwind of e-commerce gaining traction in the pandemic economy. The risk is that valuations are unforgiving: They would fall hard and fast if growth slows.
That’s a bet Ellison is willing to take. “I’m not really concerned about Square’s valuation,” he says. “The payment processors are the runway to the future for equity performance. The equity value in balance-sheet companies like banks is just not there anymore.”