Financial Technology (fintech) uses software, algorithms, analytical tools to develop platforms that both consumers and businesses can access to fulfill their financial needs online. It’s considered an emerging industry and has quickly matured into a global market powerhouse, but actually, the concept of consumers and businesses using web-based services to manage their finances isn’t new at all. Personal wealth management has been around for over a decade, and business-to-business (B2B) financial links have been around even longer.
What has changed is how innovators are now using technology to provide a growing list of financial services online. Everything from bill pay to digital wallets, mobile payment acceptance, robo-advisors, and even small business accounting services are processing tens of billions of dollars’ worth of transactions and ledger entries daily. And markets are showing no signs of slowing. So what does this mean for you as an investor? It means that fintech stock investing should be somewhere in your equity class portfolio.
What makes one fintech stock different from the next?
Most fintech companies begin with one main service feature, such as payment processing or lending, and then supplement it with add-on services. Payment processing is an easy product for competitors to replicate, however. Companies can also come along and figure out a way to sell the same quality of service more cheaply. If a company intends to attract new business in a quickly changing competitive landscape, then they must differentiate themselves or risk losing business and becoming obsolete.
The companies that thrive have a culture of innovation and a conscientiousness about solving the present-day needs of their target customers. You might wonder, what types of problems can they solve? Fintech companies aim to lessen the strain of accessing financial networks in real time. The focus becomes squarely placed on the user interface (UI) and user experience (UX).
For example, Xero, a New Zealand based company, developed software as a service (SaaS) for small businesses. Companies worldwide can access Xero’s full accrual accounting platform with an associated cash account. The main product line integrates with account data through a bank feed, as well as debtor-creditor invoicing, sales tax, and reporting tools.
The strongest fintech providers will save their customers time and effort with finishing everyday accounting tasks by securely integrating third party providers (TPP). Software engineers develop application programming interfaces (API) that allow the customer platform to connect seamlessly to external organizations and accounts. They understand that business customers desire to make less-desirable tasks frictionless when at all possible.
Like index ETFs, you can invest specifically in fintech ETFs. Global X fintech ETF (FINX) contains 41 stock holdings and Ark fintech Innovations ETF (ARKF) has a range of 35 to 55 holdings. Get in touch with an experienced wealth manager if you are unsure what the current stock holdings are or what earnings reports indicate about the long-term profitability of the company.
Economics of underbanked populations
The main motivation behind the drive to develop new consumer service products is the large underbanked population. People commonly experience geographic, transportation, and economic barriers to accessing banking systems. When basic financial services needs go unaddressed, it affects industrialized and non-industrialized economies alike.
The World Bank has taken the lead in communicating to governments that when the general population has easier access to managing their income and savings, the more likely they are to have spending power and start businesses on their own. Fintech encourages the development of self-sustaining practices in personal finance.
High-tech sectors influenced by fintech
InsurTech (Insurance technology) and Regtech (regulatory technology) are the spinoffs of fintech. As their names imply, insurance products have migrated from the traditional brokered, brick-and-mortar service into a full-service online experience.
Government regulations pose a huge challenge as well as legal and business risks to companies who fail to comply. The good news is that these days, companies can pay for a service which digitizes and automates anti-money laundering (AML) rules. They also have the capability to identify illegal or questionable sources of cash and independently verify the identity of their clients.
Stock performance metrics
When reviewing established fintech companies, look closely at revenue growth rates. Year-over-year, revenue growth should be continuous. Expect for newer companies to have higher leveraged credit. Credit-to-equity ratio should decrease over time as companies become more profitable and pay down debt. It would be particularly attractive if a company were to begin paying off its loans ahead of maturity or refinance at a lower rate. This indicates that they aren’t burning through cash and management has made a concerted effort to reduce credit exposure.
When you look at gross and operating margins, you can determine how profitable a company’s business model is. How does overall EBITDA compare to net profits per share? Compare these figures to quarterly cash flow reports in form 10-Q filings. You can easily access data on fintech stocks for publicly traded companies. Pay close attention to any Form 8-K releases as companies are required to use them to report any major organizational changes.
You can also explore whether the company continues to invest in technological growth. Technology is what originally put it on the map, and they should be consistently exploring new terrain. This budget demonstrates the level of commitment to innovation. Annual meetings are often made public and contain research budgets and the like.
Common risks for fintech stocks and portfolio asset allocation
Here are a few final takeaways to keep in mind as you explore the realm of fintechs:
- Fintechs must pass a rigorous FINRA and SEC regulations. Robinhood, for example, was ultimately unable to secure an FDIC designation on it’s high-yield interest (3%) checking account.
- Larger companies are already consolidating, so depending on which end of the stock merger you’re invested in, this will impact your stock price.
- Be proactive and check with a seasoned wealth manager for advice about trading fintech stocks and ETFs.
As with introducing any new equity class product into your portfolio, it’s beneficial to understand the effect that the new investment has on your total asset allocation. An experienced financial planner can help you to rebalance the level of risk to your portfolio, if that’s your concern, and help you assess your entire financial situation so that you feel confident you are doing everything possible to keep your investments flourishing.
SD Mayer is committed to providing holistic financial advice to all its clients. Our wealth managers have decades of experience and can help you develop a strategy for your fintech stocks. Contact us today to get started.