Best in breed: Scott Phillips

Before investing in financial technology, check the company really does fit the disruption description

Last month we looked at the technology sector of the ASX, and I made the point that adding the suffix “tech” seems to be good for business – and for share prices.

I stand by that, but – in part because it’s a growing sector, and in part because its prominence earns it a separate review – this month we’re taking a deeper dive to find the best financial technology (fintech) company on our market.

Befitting a term that is three parts marketing and one part investing, fintech covers a lot of ground. Banking, funds management platforms, app-driven financial services and neobanks have all claimed their place in this sector, with sometimes dubious credentials. After all, it’s arguable (perhaps self-evident) that Commonwealth Bank, say, is as much a technology business as your favourite buy now, pay later player.

Am I being a wet blanket? Perhaps. But I’d rather call a spade a bloody shovel, even as we then move into this sector to find our favourite. And not just out of pure pedantry, either; it’s important to realise that investor sentiment is heightened – to put it politely – in the fintech sector, so you should expect share prices and investment returns to be volatile as a result and you should be careful to separate hype, hope and honesty.

With that out of the way, let’s get into the companies themselves. What this new breed of financial technology businesses have in common is that they all have their sights set on innovating to disrupt the status quo in what is a very large and potentially very lucrative sector of our economy. While banks, brokers and insurance companies are worried about branches, legacy software and modernising their cultures (and are still dealing with their labyrinthine structures, poor behaviour and regulatory missteps), they’re also trying to protect profit margins and deliver growth and dividends for shareholders.

By contrast, the new players tend to be small, agile, laser-focused and blissfully free of the calcification that plagues even the most culturally aware legacy business. In a very simple analogy, while Woolworths is busy trying to be (almost) everything to (almost) everyone, Aldi is succeeding by offering something very specific and very targeted. The online-only banks are another example. Finding and exploiting a niche, while your competitors are trying to cover the waterfront, is a very smart strategy for a would-be disruptor. It also tends to be true that, like Kodak, which invented the digital camera but buried it to “save” the film business, incumbents tend to want to take less risk and stay with their core operations.

These disruptive businesses also tend to be characterised by having very keen and supportive customer bases. When you do something more quickly, efficiently, easily or seamlessly than your competitor, your customers notice … and love you for it. Those customers, then, tend to be quite “sticky” – they hang around for a long time – and tend to be evangelists for your business, too.

While, as consumers, our minds immediately (and reasonably) turn to the phalanx of buy now, pay later providers, business customers overwhelmingly feel the same about payments providers, funds management platforms, financial dashboards and payment solutions.

Scott Phillips is The Motley Fool’s chief investment officer. You can reach him on Twitter @TMFScottP and via email ScottTheFool@gmail.com. This article contains general investment advice only (under AFSL 400691).