A remarkable changing of the guard is happening in finance.
This week, the market capitalization of fintech payments firm Square exceeded that of Goldman Sachs, the 151-year-old investment bank, for the first time.
Almost exactly two months earlier, PayPal surpassed Bank of America, the second biggest lender in the U.S., in market cap. That move made the online payments pioneer worth more than every American bank except for JPMorgan Chase.
The meteoric rise of these two payments companies solidifies the arrival of the new guard: Firms that began as niche players in overlooked corners of finance that are growing rapidly along with the rise of e-commerce and digital payments. Shares of Square have surged more than 140% so far this year, while PayPal has climbed 90%. Meanwhile, the KBW Bank Index has fallen by 32%.
“It’s pretty stunning to look at some of these fintech companies and the credit they’re getting today,” Devin Ryan, analyst at JMP Securities, said in a telephone interview. “The market is distinguishing between companies’ future growth and what they’re willing to pay for that today, and financials are viewed as a more mature, highly-regulated industry.”
The coronavirus pandemic has accelerated the penetration of digital payments across entire industries, resulting in double-digit revenue growth at PayPal and Square in the second quarter. And central banks’ emergency actions to prop up markets starting in March, coupled with federal stimulus payments to households, have resulted in more dollars chasing growth, benefiting fintech and technology shares.
Meanwhile, thanks to the pandemic, banks including JPMorgan and Bank of America have collectively set aside tens of billions of dollars for expected defaults on credit cards, mortgages and commercial loans. And the industry’s profitability will likely be pressured for years as the Federal Reserve keeps its benchmark interest rate at zero.
There are several ways to look at the divergence in performance: New vs Old, Technology vs. Finance, Growth vs Value, even West Coast vs East Coast. But perhaps the key distinction is that the new guard embody digital platforms that benefit from scale more than banks, which are still mostly in the business of operating physical storefronts and deploying massive balance sheets to make loans.
“PayPal is still mostly about its payments business, and they can benefit from operating leverage in a way that banks just can’t,” said Conor Witt, a research analyst at CB Insights.
To be sure, the valuations of popular technology companies were getting stretched ahead of a sharp pullback on Thursday, and banks could prove to be the better value. There have been signs of froth in the market for months as names like Tesla and Apple rose day after day, and Thursday the tech sector had its biggest decline since March.
Square’s market cap reached $70.7 billion on Monday, above that of Goldman’s at $70.5 billion. The pullback on Thursday meant that Goldman edged out Square later in the week. PayPal’s market cap was $247.5 billion as of Thursday, compared to Bank of America’s at $225.4 million.
Ryan argued that some banks, especially Goldman Sachs, weren’t getting enough credit for their high-growth digital initiatives. But the longer term trend is clear, he said.
“There’s this arms race in digital finance, and the legacy firms have legacy infrastructure that they’re trying to retrofit, and legacy operating margins,” he said. “Firms that start off with a digital backbone don’t have those issues, so they have a lower cost to deliver services. I think some incumbents will be left in the past.”
With reporting from CNBC’s Robert Hum
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