Credit Cards Are Getting Expensive!

There has been a lot of media coverage suggesting that stocks are becoming overvalued. There have even been a few articles that go so far as to call the market "bubbly" and "heading for a crash." While this is a bit of an overstatement, there are indeed some areas of the market that look to be getting ahead of themselves and may be due for a correction.

The payment processing sector, and MasterCard (MA 0.56%) in particular, just seems to be going up, up, and up. Let's take a look at the space, and if there may be some values that are still worth a look.

In the payment processing space, two names tower over any competition: MasterCard and Visa (V 0.33%). These companies are different from the other major credit card brands like American Express (AXP -0.74%) in that they merely provide payment processing and support services -- they don't actually issue the credit cards that bear their brands.

Not quite a bubble, but...
Both companies have similar business models, and both are beginning to get expensive. 

Visa trades at about 26.8 times the $7.59 per share it is expected to report this year. Earnings are expected to rise by 17% annually over the next two years, so this valuation looks a little high but somewhat reasonable. The company has exhibited strong growth in emerging markets over the past few years, as well as in the "next frontier" of mobile payments, which should continue to be a major growth driver going forward.

MasterCard looks even pricier, and appears to be a stock that simply can't go down. Since 2010, MasterCard shares have risen by about 250% in a very linear fashion from the $200 range to the current all-time highs of more than $700. The linear rise indicates that this is not quite "bubble" behavior, but simply a stock that has gotten ahead of itself.

Source: TD Ameritrade.

While the company has done an excellent job of growing revenue and profits over the past several years, the problem is that at some point the growth becomes unsustainable. There is simply not enough room to rise at a 20% annual rate forever.

MasterCard trades for almost 28 times current year earnings, which is certainly justified by the company's revenue and earnings growth rates over the past few years. However, growth is expected to slow down, not only because the company is too big but due to slower global economic growth. The growth of international economies has been one of the main driving forces of the industry, and investors are betting it will continue.

MasterCard is projected to earn $26.17 this year, $30.73 in 2014, and $36.35 in 2015 for annual earnings growth of about 17%. That is equal to Visa, which still has several advantages, including better international growth and a more recognizable brand worldwide, not to mention a slightly cheaper valuation.

An alternative: similar but different
American Express is a viable alternative that is looking more attractively valued at current levels, but is still expensive on a historical basis. Unlike the other two companies, American Express issues its own cards and has a leading position in global travel services.

The company's name is practically synonymous with the concept of a traveler's check, and it has done an excellent job of improving its international revenue stream over the past few years. More than half of American Express' revenue comes from U.S. card spending (interest and fees), a revenue stream that neither Visa nor MasterCard has (at least not directly). 

Additionally, American Express is the cheapest company on a valuation basis, by far. It is expected to report earnings of $4.91 per share this year, meaning it trades for 16.8 times current year earnings, much better than the other two. While annual earnings growth is expected to be somewhat less (around 12% annually for the next three years), its valuation is more justified.

Looking ahead
While the two major payment processing companies may be a little expensive right now, the leading direct card issuer is still a pretty good value. However, all three of these are excellent, well-run companies with a lot of potential, and even Visa and MasterCard would be worth a look on a pullback.