Trading Nation

Digital payment stocks Square and PayPal surge this year, but a market analyst has a warning

Ahead of AmEx earnings, traders check out the payments space

Credit card stocks American Express and Visa may be underperforming the market this year, but it's a different story for the digital payment players.

Square and PayPal have soared 180% and 89%, respectively.

Don't take PayPal's and Square's outperformance as evidence they can continue to outperform, though, warned Gina Sanchez, founder and CEO of Chantico Global and chief market strategist for Lido Advisors.

"These are stocks that have actually expanded from momentum and multiple expansion, but the underlying decline in spending is actually hitting all of these companies pretty squarely in the gut," Sanchez told CNBC's "Trading Nation" on Thursday. "The reality is that the digital plays are extremely overvalued."

Square trades at 167 times forward earnings and PayPal at 46 times. Both have a higher multiple than Visa at 34 times and American Express at 17 times.

Square and PayPal likely trade at higher valuations compared with Visa or Amex given their position at the intersection of finance and technology. However, Sanchez said that reasoning is not justified.

"They're both driven by the same thing — consumption. You need transactions in order to support all of these plays, and so I would argue that psychologically you can tell yourself that [justification] but I don't know that it's going to play out over a period in your portfolio," said Sanchez.

Quint Tatro, president of Joule Financial, is more bullish on the tailwinds driving Square and PayPal higher, though.

"There's no question the shift toward payment methodology is going toward these new methods, these new companies. I mean, take a look at PayPal's Venmo. It just rolled out basically a debit card that the generation that is using that is using that much, much more than a traditional debit or credit card," Tatro said during the same "Trading Nation" segment.

Tatro also noted the valuations do not look as overstretched as Sanchez argued.

"Look at PayPal and look at the incredible amount of ... free cash flow that this company is kicking off. And when you do something, again, as traditional as a discounted cash flow from an intrinsic value standpoint, the company's not that overvalued. They're growing very, very rapidly, and with that free cash flow they're able to buy companies and create accretive earnings," he said.

PayPal reported $3.9 billion in free cash flow in fiscal 2019. It is expected to generate $5.95 billion in free cash flow in 2020.

Disclosure: Joule Financial holds shares of Square and PayPal.