Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
That's the question Sears Outlet's website asked me earlier this week. And here's the funny bit: I actually wanted to pay with my new American Express (NYSE:AXP) card, but because of a coding glitch on Sears' website, the field wasn't big enough to enter all the required numbers. To work around that snafu, I was forced to add my AmEx card to my PayPal account, then charge my new dishwasher to the AmEx card on PayPal.
So I ended up choosing PayPal over Mastercard and Visa after all -- and I'm not the only one.
Identifying the players
Last night, analysts at Swiss megabanker UBS announced they were initiating coverage on four of the world's biggest payment processors: Mastercard, Visa, PayPal, and American Express.
Running down the contenders, UBS determined that Visa and Mastercard would both benefit from "sustained secular trends of growth in personal consumption expenditures and increasing adoption of electronic payments," according to a write-up on TheFly.com. By UBS' estimation, both Mastercard and Visa will likely enjoy "annual revenue growth rates of up to 11% beyond" fiscal year 2018. Accordingly, the analyst believes both stocks will rise in value over the next year, with Visa going from $130 a share to about $141 (8.5% growth) and Mastercard rising from $191 a share to $205 (7.3% growth).
Both stocks thus have respectable profit potential. Neither one is spectacular, however. UBS rates both Mastercard and Visa only neutral.
Picking PayPal to win
Not so with PayPal.
Positing a $90 target price for the online payments specialist, UBS sees 15% profit potential in PayPal stock. As UBS explains, PayPal is expected to benefit from "sustained volume growth" among its "core constituencies" -- presumably, even better growth than the analyst sees at Mastercard and Visa. Additionally, merchants are driving demand for its payment processing and gateway services, says UBS. According to the analyst, around the globe, some 94% of small and medium enterprises that UBS has surveyed plan to increase their acceptance of electronic payments.
Thus, while PayPal stock may cost a bit more than Mastercard or Visa (when valued on P/E), the company's superior growth and profit potential has UBS thinking PayPal is more of a buy than either of the two premier credit card names.
And American Express to win even bigger
But there's only one stock that UBS calls its "top pick among Payment Networks": American Express.
This is actually a curious pronouncement, because by UBS' own admission, AmEx stock is only likely to hit $115 a share over the next 12 months -- a 14% increase from today's share price of $101 and change, and thus a bit lower than the profit potential UBS foresees for PayPal.
So why does UBS prefer AmEx?
UBS forecasts "positive" trends across the payments industry, predicting "robust growth" and a "total addressable market for electronic payments" estimated at $95 trillion annually. With regard to AmEx in particular, UBS expects the company to show "accelerating discount volumes and loan growth." Such a move could potentially bring the fees AmEx charges more in line with its competitors, and increase acceptance of AmEx's traditionally more expensive cards by retailers (as explained in this article on AmEx's Q4 earnings report earlier this year).
UBS believes these moves will drive earnings growth at AmEx, and support "a high-level stability of profitability," which will permit AmEx to "beat and raise" estimates all year long.
Which stock should investors prefer (if any)?
So that's why UBS prefers AmEx over PayPal -- and both AmEx and PayPal over Mastercard and Visa. But which of these stocks should investors prefer?
All four, it must be admitted, look pretty pricey in terms of P/E. At just under 33 times earnings, Visa stock is actually the cheapest of the four companies named. Mastercard costs 52 times earnings, and PayPal (after a quick bump higher on last night's UBS note) now costs 55 times earnings.
American Express stock meanwhile, sells for 34 times earnings. That's nearly as cheap as Visa, which may help explain UBS' fondness for the stock. That being said, most analysts surveyed by S&P Global Market Intelligence still see American Express growing its earnings only 10% annually over the next five years. That's roughly half as fast as the growth rates most analysts project for the other three payments processing stocks (20% for MasterCard, 19% for PayPal, and 18.5% for Visa).
If you ask me, Visa, with the lowest P/E of the bunch and a projected growth rate nearly as high as the highest, is closest to being "buyable" at a PEG ratio of 1.8 -- but to be perfectly honest, I don't see any of these stocks being cheap enough to buy at today's high prices.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Mastercard, PayPal Holdings, and Visa. The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.