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Does Visa Deserve Its Bullish Valuation?

By Ryan Downie – Updated Aug 21, 2020 at 7:04PM

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Visa is riding the fintech wave, and the stock is expensive as a result. Investors should still consider holding shares.

Visa (V 0.97%) leads the global digital payment market with a secure payment network that is capable of processing over 65,000 payments per second. The company does not extend loans or credit, but offers a technology platform that allows financial institutions and vendors to transact with credit, debit, and gift cards. The company has issued bullish guidance for next year, indicating internal optimism about the growth prospects in the near term. Is this war-on-cash stock worth buying at today's price?

Visa's valuation is bullish but in line with peers

Visa stock currently trades at 30.3 times forward earnings and 35.5 times free cash flow, both of which are slightly lower than peers such as Paypal and Mastercard, but much higher than American Express. Visa's EV/EBITDA ratio of 26.9 follows a very similar pattern. Analysts are forecasting 15% annual earnings growth over the medium term, resulting in a price-to-earnings-growth (PEG) ratio of approximately two. This battery of valuation metrics suggests that Visa is priced in line with peers based on multiple profitability measurements, even when adjusting for variations in growth outlook and capital structure.

Person holding credit card and typing on laptop

Image source: Getty Images.

As a further kicker for investors, Visa pays a 0.55% cash dividend yield, which helps to deliver some income returns independent of market price performance. The company has also consistently returned value to shareholders with a stock repurchase program that has a buyback yield above 2%, which helps to augment market returns through anti-dilution. The overall dividend and repurchase activity is rather modest compared to companies in other sectors, but it is nonetheless a nice bonus to have some reliable upside along with the growth potential. 

Visa has some very pleasing operational metrics

Visa leads its peer group with a stellar 67% operating margin and a 52.6% net profit margin. Only Mastercard approaches these figures, but it's still roughly ten percentage points lower. This is not an aberration, because the company's margins have been stable for the past five years, and its operating margin was still over 56% for each year of the past decade. This spread has allowed the company to deliver an excellent return on invested capital (ROIC) of 26.5%, which is double the industry average and far in excess of the company's 6.8% weighted average cost of capital. Visa's operating metrics indicate an efficiently run organization, with high-quality earnings that translate to cash flows.

Visa is in a great position to capitalize on global trends

Financial technology is rapidly changing the ways that people transfer money and pay for goods and services. Digital transfers, blockchain, and other new solutions are quickly disrupting the market, creating new players and forcing incumbents to adapt through acquisition. The result is a fairly fragmented industry.

It is difficult to make long-term forecasts at a time with so much innovation and change on a global scale, but Visa is in a great position to benefit from market trends. The company has shown a willingness to participate in innovation through acquisitions, having purchased Verifi, Payworks, and Earthport in 2019. These will provide solutions for issues related to disputed charges, cross-border transfers, and payment efficiency. Visa is participating in the benefits of blockchain, having announced its use of the technology to facilitate B2B payments with B2B Connect.

Visa has a massive market share, and there are switching costs associated with moving away from Visa's services. This is especially true for the largest providers of goods and services, which would require a substantial overhaul to completely revamp payment systems to a different competitor. The fact that it's hard for businesses to leave creates a moat that protects the company's fundamentals from rapid deterioration. Even in situations of rapid market shifts, such as the wide-spread adoption of Square's mobile payments platform, new solutions can actually function hand-in-hand with Visa, so some competitive innovations might even benefit the company's legacy business.

Overall, consumers are showing a declining preference for cash payments, and Visa is in an excellent position to capitalize on this evolving trend. Fintech and payment solutions will be buoyed fundamentally by strong tailwinds for the foreseeable future, and investors would be wise to gain some exposure to these trends. The nature of innovation makes it impossible to identify one clear winner in the group, especially if changes in blockchain and digital currency have even greater effects than anticipated. However, Visa makes a clear case to be among the companies best suited to provide exposure to the boom.

Ryan Patrick has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Mastercard, PayPal Holdings, Square, and Visa and recommends the following options: short January 2020 $70 puts on Square and short January 2020 $97 calls on PayPal Holdings. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Visa Stock Quote
$213.79 (0.97%) $2.06
American Express Stock Quote
American Express
$154.15 (0.14%) $0.22
Mastercard Stock Quote
$351.29 (0.76%) $2.65
PayPal Holdings Stock Quote
PayPal Holdings
$80.08 (-0.83%) $0.67
Block, Inc. Stock Quote
Block, Inc.
$63.38 (-0.84%) $0.54

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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