Analysts Debate: Is Visa Still a Top Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Visa (NYSE: V  ) , the world's largest electronic payment processing network.

Visa by the numbers
Here's a quick snapshot of the company's most important numbers:

Statistic

Result (TTM or Most Recent Available)

Market cap

$116.5 billion

Price/book

4.4

Price/sales

10.5

Forward P/E

20.7

Cash/debt

$2.72 billion / $0

Revenue breakdown (mrq)

Service: $1.37 billion
Data processing: $1.15 billion
International transaction: $0.83 billion
Other: $0.18 billion
Incentives: ($0.57 billion)

Competitors

MasterCard (NYSE: MA  ) American Express (NYSE: AXP  ) Discover Financial Services (NYSE: DFS  )

Source: Yahoo! Finance, Visa quarterly report, mrq = most recent quarter.


Source: U.S. Navy. Commons.wikimedia.org. 

Sean's take
There is no such thing as a riskless investment, but I have to admit that Visa comes extremely close. Aside from a global recession, Visa has positioned itself in multiple respects for sustained low double-digit growth.

To begin with, Visa and its biggest rival MasterCard are merely payment processors. American Express and Discover Financial Services act as both payment processors and lenders, which allow them to double-dip in profits, but it also exposes them to bad debt write-offs if the economy weakens and consumers stop paying their bills. As simple as payment processing sounds, it leaves Visa and MasterCard with no bad debt exposure and the freedom to grow with little risk.

Visa is also making big inroads overseas. The majority of global transactions are still conducted in cash, which leaves a moat of opportunity in emerging markets. In its most recent quarter, cross-border volume grew by 10%, which I believe should be a fairly consistent baseline for the company moving forward.

Prepaid debit cards are another of immense opportunity for Visa because many people had their credit harmed during the financial crisis. With annual prepaid debit card growth of 15% to end last decade, it's still a solid growth opportunity that's still largely untapped.

Finally, Visa has done a great job of returning money to investors via a dividend that's more than tripled over the past four years. It's also added billions in share repurchases which reduce the outstanding share count and make the company appear cheaper relative to its profits.

You can read a more detailed analysis about the key points that make me feel confident about Visa's future by clicking here. However, in a one sentence summation, these factors make Visa a perfect buy-and-hold candidate.

Alex's take
In the long run, it makes sense to bet on the expanding use of credit cards around the world. As Sean pointed out, most transactions are still done in cash, but there's plenty of room to expand in the non-cash transaction volume before Visa even needs to consider chipping away at all those cash payments. In North America and Asia, 60% of the non-cash payments are made with credit or debit cards, but less than 40% of non-cash transactions in Europe or the BRIC nations are credit-based. Simply expanding its reach in the extant non-cash sector would be enough to drive growth before an assault on the cash economy needs to take place.

The downside risk to investing in a company working with financial services is that economic headwinds often hurt the financial sector harder than others. But Visa's superior market position and better business model (also highlighted by Sean earlier) actually makes it a viable defensive investment during a recession or a slowdown, as you can see from this graph of the company's share-price movement relative to its peers:

V Total Return Price Chart

V Total Return Price data by YCharts.

It's true that Visa is more expensive than its peers, but I've calculated a more normalized set of valuations discounting the one-time litigation charge that affected the company's 2012 results, and on those measures, Visa is valued quite similarly to MasterCard, a competitor half its size and with a very similar expectation of growth. You can read more of my reasoning by clicking here, but the gist of it is that I agree with my fellow Fools. Visa has a great shot at long-term outperformance.

Travis' take
Visa's real competitive advantage is in what's known as a network effect. Payment processors require merchants to have customers with Visa and customers require merchants that take Visa. Starting a payment processor is a chicken and egg conundrum and would be a nightmare to execute. But once you've built a payment processor network, it feeds on itself, drawing more merchants as customers sign up and more customers as more merchants sign up.

To demonstrate the power of Visa's network effect, think about how ubiquitous Visa has become. I went to a liquor store about a month ago that didn't accept Visa, and I almost went into a tirade. How could a successful business not accept Visa? This is blasphemy, I thought.

As a result, Visa has built a business that's nearly impenetrable by outside forces, and like Sean pointed out, it doesn't have to take credit risk. It's an expensive stock at 20.7 times forward earnings, there's no doubt about that, but great companies don't come cheap, and neither does Visa.

I'll happily go along with an outperform call, and I actually think the combination of both MasterCard and Visa is really the right way for individual investors to play this great space. For more on my outperform call, see my full article here.

The final call
That would indeed be a unanimous outperform CAPScall for Visa. Once again, the conclusion was the same for all three of us; however, the thinking that got us there took each of us down a different path. From Visa's network effect, which feeds upon itself, as Travis points out, to Visa's opportunity in non-cash transactions, according to Alex, and its incredible overseas opportunity coupled with its growing shareholder payback incentives, as I (Sean) noted, we are all led to believe Visa is the epitome of a buy-and hold selection.

If you'd like a glimpse into our previous CAPScalls, I'd encourage you to visit our TMFYoungGuns CAPS page, where we are currently outperforming the market by 459 points on 26 (soon to be 27) active picks. 

With so much of the financial industry getting bad press these days, it may be a greedy when others are fearful moment. Not surprisingly, some of Warren Buffett's biggest investments are in the space. In the Motley Fool's free report, "The Stocks Only the Smartest Investors Are Buying," you can learn about a small, under-the-radar bank that's too tiny for Buffett's billions. Too bad, because it has better operating metrics than his favorites. Just click here to keep reading.


Read/Post Comments (7) | Recommend This Article (23)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 13, 2013, at 9:51 PM, TMFVicki wrote:

    I am confused by your chart. I followed your link and went to YCharts. For the dates May 12, 08 through May 13, 13 -- Visa increased from $79.23 to $178.68 (225%); MC increased from $286.39 to $557.20 (194.56%); AE increased from $45.56 to $69.80 (153.2%); and DFS increased from $17.08 to $45.20 (264.64%).

    What does total return mean and why does DFS end up being such a small number when it seems like it grew more than the other three over the time period displayed?

  • Report this Comment On May 14, 2013, at 8:12 AM, TMFBiggles wrote:

    @ vicki08 -

    The graph runs from the market's high point in the fall of 2007 to the end of 2009. You'll get different price changes if you use different dates than I did. This particular graph was meant to show defensive strength during the worst part of a market crash, not a five-year change.

    Total return includes reinvested dividends.

    - Alex

  • Report this Comment On May 14, 2013, at 4:45 PM, TMFVicki wrote:

    Thanks Alex.

    So, the take away is that in a financial downturn Visa is the best stock, but, otherwise there is more competition.

    Thanks for explaining how these stocks differ in their approach.

    Vicki

  • Report this Comment On May 15, 2013, at 12:30 AM, dsciola wrote:

    Interesting analysis here and in adjunct articles by each analyst above...

    However, a part of me wonders if nows the time to sell V and MA and buy AXP and DFS instead...

    Given V and MA's Total Return since the Great Recession accompanied with their currently higher than normal valuations, their gains may have run their course...

    ...if the market really is improving and consumers as well as businesses are returning to using leverage/debt, that tells me then that V and MA are likely 'at the top', whereas AXP and DFS are 'at the bottom'...

    ...My thinking here is that AXP and DFS benefit when consumers/businesses return to using debt, due to their 'double-dipping biz model', whereas V and MA do not and even lose market share, revenue, and earnings to AXP and DFS in this case.

    Sean/Travis/Alex, ur thoughts?

  • Report this Comment On May 17, 2013, at 10:32 PM, harmonyjoe wrote:

    I don't understand your thesis dsciola. you must have used either Visa or Mastercard yourself, probably even today..How could they possibly lose market share? they do provide credit to the card holder. The only difference is that it's through a bank, unlike American Express and Discover which provide credit through it's own auspices and thus gain an additional profit on the vig. Visa and Mastercard profits may fall against American Express and Discover if the American Consumer returns to using debt, but certainly not Market Share.

  • Report this Comment On May 23, 2013, at 1:12 AM, rocky6969 wrote:

    Actually, I use both AXP and V, not MA yet.

    My point is this...

    If the market has rewarded V and MA with high returns and high valuations, relative to AXP and DFS, since the crash due to V and MA's business model, relative to AXP and DFS,...

    ...more specifically, V and MA have the more conservative business model and are not exposed to leverage, whereas AXP and DFS are more exposed to leverage and directly lend to consumers...

    ...and consumers believing the economy has improved thus return to using leverage, thus boosting earnings of AXP and DFS relative to V and MA...

    ...then perhaps the market will reward AXP and DFS more going forward, relative to V and MA, with higher returns and higher valuations...

    Yes perhaps mrkt share may not change. But, if AXP and DFS benefit from their levered business model and generate higher earnings, relative to V and MA, investors may pour more $$$ into AXP and DFS than into V and MA or even pull $$$ out of V and MA into AXP and DFS.

    To me, at the end of the day, its all relative and valuation/returns comes down to comparables. Even 'fundamental' value at its core, sub-atomic level is really just comparables.

    Your thoughts?

  • Report this Comment On May 23, 2013, at 2:05 PM, dsciola wrote:

    Oh BTW, that last post was me posting on my roommates computer per above...hence the odd screen name and not my regular one, mea culpa

    Dom

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