Here's How You Can Make Money From America's Credit Card Spending

More credit cards are being issued, and more purchases are being charged to those cards. What's the best way to capitalize on this?

May 4, 2014 at 3:30PM

As the largest U.S. banks have now reported their first quarter earnings, a recurring theme is a noticeable increase in consumer lending, particularly in the form of credit cards. In fact, Moody's recently issued a report which predicted higher card spending and improved asset quality for the rest of 2014. As an investor, you have several ways to capitalize on this trend:

Credit Cards

You could buy shares in one of the big banks leading this trend, like Bank of America (NYSE:BAC). Or, you could buy one of the major payment processors like MasterCard (NYSE:MA) to capitalize on the higher fee income this will generate. Finally, you could buy a company whose main business is issuing cards, like American Express (NYSE:AXP) for a more aggressive way to capitalize on the trend. What is the best play for you?

Big banks: how much do shareholders stand to gain?
So far this earnings season we've seen impressive growth in most banks' credit card business. JPMorgan Chase reported a 10% increase in credit card sales volume for the first quarter, and this is despite the unusually bad weather we saw. 38% of Wells Fargo's retail customers now have a credit card account with the bank, an impressive increase from 34% in the first quarter last year.

Bank of America issued over one million new credit cards during the quarter, which is a pretty impressive number. For 2013, retail credit card spending per account was 6% higher than 2012, which could mean some serious money when combined with the increased number of open accounts.

As of year-end 2013, the total outstanding credit card balances for Bank of America stood at more than $90 billion. With the bank earning an average of 10% on outstanding credit card balances, this means about $9 billion in interest income annually.  This represents almost one-quarter of the bank's annual interest income, so any significant increase could have a big impact on their bottom line.

Payment processors
This type of company makes its money primarily by charging fees to merchants who accept their cards which generally run about 2-3% of the purchase amount, as well as fees collected from the issuing of their cards. So, while Visa and MasterCard's income is directly tied to the amount of credit card spending, they don't carry the risk of bad debt. In other words, they don't care if the cardholder pays his/her bill. They get their fee income regardless.

These companies certainly stand to gain a lot from the increase in credit usage, but I can't help but wonder whether the growth is already priced into the shares of companies like Visa and MasterCard. As you can see from the chart below, both companies trade for pretty high P/E ratios.

MA PE Ratio (TTM) Chart

Of the two, MasterCard seems to be the better option, even though it is more "expensive". Analysts project the company to grow its earnings at a 17% annual rate for the next three years, and the company has tremendous potential in terms of the transition to electronic payments and the growth of mobile payment solutions.  Its smaller size relative to Visa means there is more potential market share to capture.

However, both issuers have some very unique offerings and partnerships, so it's difficult to say either has a distinct competitive advantage. If the U.S. credit card industry expands over the next few years, both companies will do very well.

Card issuers
Another way to play it is with companies whose primary business is to directly issue credit cards, like American Express. With a very unique portfolio of credit card products, Amex is in an excellent position to capitalize on the trend, as virtually all of its income is tied to credit card spending.

Images

About 67% of American Express' revenue comes from domestic and foreign card services, which includes both interest and fee income from every credit card issued, so obviously this could increase significantly as more cards are issued and more is charged to the cards. Plus, a high portion of American Express cards carry annual fees ranging from about $50 to $2,500, which would give the company yet another revenue boost if it sees an influx of new accounts like the banks have.

The rest of Amex's business comes from merchant services and commercial services. This includes all payment solutions offered to businesses (like company credit cards) and the payment processing services provided to retailers and other businesses which accept the company's cards. American Express charges higher fees to its retailers than other card issuers (about 3.5% vs. 2-3% for others), so it stands to gain the most fee income from increased credit card spending.

Is one better than the other?
American Express is my top pick on the current credit card trend, simply because it's a pure play, as opposed to banks which have to worry about things like mortgage lending and investment banking. Visa and MasterCard are great companies, and stand to gain a lot from this, but the stocks are a bit too highly valued right now. Amex trades much more cheaply, and makes money on both fees and interest income.

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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends American Express, Bank of America, and MasterCard. The Motley Fool owns shares of Bank of America and MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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