2016 has not been kind to investors in Mastercard (NYSE:MA) stock, or to Visa (NYSE:V), either. Over the past 12 months, Mastercard shares have gained less than 5% in price, versus a more-than-10% gain for the S&P 500 as a whole. Visa stock has fared even worse, rising less than 1%.
But could happy days be here again?
Over the past two days, Mastercard and Visa have both benefited from positive analyst reports, with Cowen & Co. (an ace stockpicker, rated 90.33 on CAPS) making bullish noises on Wednesday, and now Merrill Lynch (even better -- a 94.03 rating) issuing actual upgrades today. What do they have to say about the stocks, and why do they expect them to outperform the market?
Here are three things you need to know.
1. "Strongly" recommending Visa
Let's begin with Cowen. This analyst was already bullish on both Visa and Mastercard, rating each outperform. But on Thursday, Cowen reiterated its stance, and pounded the table on Visa in particular. As noted in a TheFly.com update yesterday, Cowen now "strongly recommends" Visa stock because the stock is selling for its "most favorable valuation in over a year."
Although selling for nearly 32 times earnings, and expected by most analysts to grow profits at less than 17% over the next five years, Cowen thinks Visa stock will surprise us, and grow its revenue at an accelerating pace in 2017.
2. Recommending it why?
As for why Cowen is so bullish, the banker sees several trends working in Mastercard's and Visa's favor -- but Visa especially. Says Cowen, cross-border payments volume is likely to increase with the Visa Europe acquisition. At the same time, foreign exchange headwinds that depressed many companies' earnings earlier this year are beginning to abate, now that the dollar has already appreciated so much.
More generally, the analyst also argues that both Visa and Mastercard will benefit from consumers' increasing use of online payments and digital wallets. And in this regard, one factor likely to further inflate earnings at Visa and Mastercard is the price of gas.
Cheap for much of 2016, gasoline prices really have only one place to go at this point -- up. When precisely gas prices begin to rise again may not be clear, but once they do, consumers' established preference for paying at the pump with credit cards is certain to boost earnings at both Visa and Mastercard.
3. The Trump effect
Even more generally, Cowen notes that while many stocks have benefited from a sort of "Trump effect" these past few weeks, Mastercard and Visa have been entirely left out of the Trump trade. Indeed, since the Nov. 8 election, Mastercard shares are down a small fraction of 1%, while Visa shares have fallen 3.5%! Cowen believes this is a mistake, arguing that the same expectations for higher inflation that have helped bank stocks, and for tax reform and economic growth that have helped boost the Dow past 20,000, will certainly benefit Visa and Mastercard as well.
So why is this happening? Merrill Lynch makes an observation this morning, arguing many institutional investors have been focusing on "cyclical stocks" such as are found in the steel industry, in mining, oil, and especially in shipping. Muses Merrill, investors may have simply overlooked the benefits that a Trump presidency may offer to Visa and Mastercard. But Merrill, at least, sees these advantages as real, and argues both Visa and Mastercard are buys, assigning them price targets of $92, and $130, respectively.
The most important thing: Valuation
After watching seemingly every other stock in the market zoom higher after Trump's election, while Mastercard stands still, and Visa sinks, I have to think that Cowen and Merrill Lynch have a point. Leaving these two superb money-makers on the table while buying every other stock on the planet doesn't seem to make much sense -- at least not at first glance.
At the same time, though, I have to say that I still find the valuations of Visa and Mastercard troubling. Priced at 31.7 times earnings, and projected to grow at 16.5% over the next five years, Visa stock sells for a PEG ratio of nearly 2, which tells me it's already overpriced by as much as two times -- and unlikely to produce the 20% gains that Merrill Lynch's $92 price target implies. Mastercard, priced at 29.1 times earnings on a 15.1% projected growth rate, doesn't look much better. I honestly don't see how it pulls down the 24% gain that Merrill is forecasting -- not if forecast growth rates are anywhere close to accurate.
Long story short, I just can't bring myself to support the bankers' buy ratings on either of these two stocks. Even selling at the "most favorable valuation in over a year," they still look too expensive to me.
Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on Motley Fool CAPS, publicly pontificating under the handle TMFDitty, where he currently ranks No. 345 out of more than 75,000 rated members.
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