Putting MasterCard's New Capital Plan to the "Buffett Test"

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

Stocks fell for the second day running, as the S&P 500 fell 1.1%, while the narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) lost 0.8%.

Late yesterday, MasterCard (NYSE: MA  ) announced three capital actions, but only one is unequivocally beneficial to shareholders. To see why, I'm going to draw on the knowledge of a legendary value investor, Berkshire Hathaway (NYSE: BRK-B  ) CEO Warren Buffett.

MasterCard's three capital actions are:

  • A 10-for-1 stock split of the company's common stock to be effected through a stock dividend;
  • An 83% increase in the company's quarterly cash dividend to $1.10 per share;
  • A new share repurchase program with an authorization up to $3.5 billion of its Class A common stock.

Stock split: No economic effect, but detrimental to the shareholder base
Splitting a stock is like cutting a pizza into a greater number of slices. No pizza is created in the latter process and, similarly, a stock split has no effect on a stock's intrinsic value. However, it sends the wrong message with regard to the shareholders a company is trying to attract. Indeed, as Buffett wrote in his 1983 letter to Berkshire shareholders:

Were we to split the stock or take other actions focusing on stock price rather than business value, we would attract an entering class of buyers inferior to the exiting class of sellers. At $1300, there are very few investors who can't afford a Berkshire share. Would a potential one-share purchaser be better off if we split 100 for 1 so he could buy 100 shares? Those who think so and who would buy the stock because of the split or in anticipation of one would definitely downgrade the quality of our present shareholder group... People who buy for non-value reasons are likely to sell for non-value reasons. Their presence in the picture will accentuate erratic price swings unrelated to underlying business developments.

MasterCard's ought to do even more on the dividend
Here is what Buffett had to say on the topic of dividends in his 2012 letter to Berkshire shareholders (link opens a PDF document):

Above all, dividend policy should always be clear, consistent and rational. A capricious policy will confuse owners and drive away would-be investors... Most companies pay consistent dividends, generally trying to increase them annually and cutting them very reluctantly. Our "Big Four" portfolio companies follow this sensible and understandable approach...

MasterCard's 83% increase in its dividend might appear a little capricious, coming as it does on the heels of a doubling of the dividend back in February. However, this is the sort of caprice that investors will welcome and, crucially, the increase is eminently sustainable. In fact, based on an annualized dividend amount of $4.40, MasterCard's dividend yield is barely more than half a percent. This year's increases simply put the dividend on a path toward a more normal level, but the company can do more, particularly in light of its third capital action, which looks like a less sensible use of capital:

Share repurchases: Value ought to be the key criterion
Here is Buffett on share repurchases in the 2011 letter to Berkshire shareholders (link opens a PDF document):

Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company's intrinsic business value, conservatively calculated... It doesn't suffice to say that repurchases are being made to offset the dilution from stock issuances or simply because a company has excess cash. Continuing shareholders are hurt unless shares are purchased below intrinsic value. The first law of capital allocation -- whether the money is slated for acquisitions or share repurchases -- is that what is smart at one price is dumb at another.

MasterCard's repurchase program meets Buffett's first criterion, as it doesn't come close to jeopardizing the ability of the company to fund its operations and growth. However, it looks in danger of failing the second criterion; indeed, at nearly 27 times next 12 months earnings-per-share estimate, it's hard to make the case that the stock is currently selling "at a material discount to the company's intrinsic business value, conservatively calculated."

It's always possible that MasterCard will be opportunistic in carrying out the share repurchases; however, it's worth noting that the announcement makes no reference whatsoever to intrinsic value. As such, and given the shares' current valuation, it's hard to give the company the benefit of the doubt here. The new buyback program doesn't look like it's in shareholders' best interest.

Bottom line: Great business, with room for improvement
MasterCard is a superb franchise with a wide moat -- just the sort of business Buffett favors, in fact. However, this latest series of capital actions suggests that the company has room for improvement with regard to capital allocation and corporate governance. Furthermore, while long-term shareholders can continue holding the stock, I wouldn't encourage investors to build a full position at current prices.

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  • Report this Comment On December 12, 2013, at 9:54 AM, midnightmoney wrote:

    I like your article and find it useful but can't help wondering. MA has done nothing but go up in value since it went public, with the understandable exception of 2008-09-related pull-back. How do you determine intrinsic value to a company that does nothing but go up? Doing so seems akin to determining the average flying altitude of a plane that hasn't reached its peak. I don't doubt that 27xs earning is steep, but I do wonder why analysts seems to be second guessing a stock that appears to be redefining the term 'firing on all cylinders'. Might this not be an occasion to fold and leave the spectacles over Buffet's letter there by the fireplace to get outside into the wind and do some caution tossing?

  • Report this Comment On December 13, 2013, at 9:47 AM, artofgolf wrote:

    Let me offer another perspective:

    Sometimes it's good to be the batboy for Babe Ruth. Mr. Buffett has been fantastic with capital allocation over a very long period. Most of us are not as smart as he is. My suggestion is to hitch your wagon to the best in the business and enjoy the ride. IMHO, many investors are too impatient; slow down and embrace the concept of getting rich slowly. The ownership of wonderful businesses will get you there if you ignore the day-to-day gyrations of the market.

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