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Is Mastercard a Buy?

By Nicholas Rossolillo - Updated Apr 20, 2019 at 10:55PM

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A late 2018 pullback could have teed up a buying opportunity.

Check out the latest Mastercard earnings call transcript.

Mastercard ( MA 0.60% ) had a stellar run in 2018. The stock was up 25% on the back of strong revenue and earnings growth due to rising electronic payment volumes around the globe. However, shares were up even more prior to an end-of-year correction due to mounting worries that economic growth is slowing.

Though the global economy is cooling, that doesn't mean the investment thesis for Mastercard is dead. Shares look like a deal given the company's highly profitable model and the fast pace of digital transformation that is just beginning in many parts of the world.

An elegantly simple business

Mastercard is best known for its credit and debit cards, which are issued by banks and other financial partners. Mastercard itself isn't a lender or bank, though -- instead, the company earns a fee for clearing transactions and providing other related services. It's a simple business model, and not necessarily a new one, as plastic cards have been out since the 1950s.

Nevertheless, it's an incredibly powerful business model. Revenue has been up in the low double-digits this year, but high profit margins on transaction clearing has led to even faster earnings growth.

Metric

Nine Months Ended September 30, 2018

Nine Months Ended September 30, 2017

YOY Change

Revenue

$11.1 billion

$9.2 billion

21%

Adjusted operating profit margin

57.6%

55.7%

1.9 p.p.

Adjusted earnings per share

$4.94

$3.44

44%

P.p. = percentage point. Data source: Mastercard.

Though Mastercard isn't new, it's still a high-growth concern with plenty of room to run. Cash is still by far the most common transaction around the world, but digital transformation is making the use of plastic more common. Other services provided to banks and financial partners like analytics and security also help Mastercard embed itself into the lives of consumers and the financial industry overall.

Economic growth and the increasing value of monetary payments also help Mastercard; a bigger economy generally means more card swipes and online purchases. The company's gross dollar volume (the total value of transactions cleared) was up 14% in both the first and second quarters of 2018, and increased 13% during the third quarter.

A man with a tablet inputting credit card information.

Image source: Getty Images.

Expensive but worth the money

Though the story around cashless payments sounds promising, a 12-month trailing price to earnings ratio of 39.5 may keep many investors away from Mastercard stock. Paying for four decades'-worth of profit is certainly a premium price, but it doesn't tell the whole story. The more accurate 12-month trailing price to free cash flow -- money left over after basic operations and capital expenditures are paid for -- is only 33.7.

When valuing a high-growth endeavor, though, the future is far more important. Due to its high profit margins, even small gains in revenue helps Mastercard's bottom line grow at an even faster pace. Thus, with cashless payments on the rise in many parts of the world -- propped up by a slow-and-steady expanding global economy -- the company's 12-month forward price to earnings is currently 26.0. That implies Wall Street analysts expect that profits will continue to grow at a similar clip as they have so far in 2018.

Granted, those are just estimates that may or may not work out. However, consumer and business trends toward digital transactions bode well for Mastercard. Though it may not be the cheapest stock out there, solid growth makes shares look like a good value for the long-term after the pullback in late 2018.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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