The payment industry has gone through a lot of changes in recent years, with many new fintechs emerging and threatening to disrupt the industry. That may well happen over time, but it could take a while before we can figure out who the winners and losers will be, as many are not yet profitable and have struggled in this bear market.
Through this rocky period for the markets, it has been the time-tested credit processors -- Visa (V -0.48%), Mastercard, and American Express -- that have thrived. While all three are excellent companies, I give a slight edge to one of them. Here is why Visa is my favorite payment stock right now.
Visa is (almost) everywhere
Visa is the largest credit card company in the world, and Mastercard is really the only other major competitor in the space. American Express and Discover Financial Services are slightly different animals in that they are closed-loop credit card companies, meaning they issue their own cards, lend their own money, and process their own payments.
Visa and Mastercard are strictly payment processors: They don't issue the credit themselves, their bank partners do. They simply provide the network on which transactions go through, collecting a fee each time a card is used or a mobile payment is made.
It's a simple business model that generates huge margins because there is little overhead, the networks are massive, and it is essentially a duopoly, as most payments use them, even those made through mobile payment fintechs like PayPal and Block. Visa has a history of outperforming in all markets, even when the stock market is down, like 2018 and this year. As of market close on July 21, Visa stock was down 1% for the year, trading at around $215 per share. The S&P 500, by comparison, has fallen roughly 16% year to date.
Visa is able to navigate these dips because of the competitive advantages that come from its duopoly, as well as its huge margins, which provide it with an abundance of liquidity and cash flow to continue to invest in innovations and effectively manage the downturns. It has an operating margin of 67%, a profit margin of 51%, a return on equity of 37%, and a return on invested capital of 23%. These numbers are all off-the-charts good and higher than most companies' comparable figures.
Payment volumes remain high
The primary economic indicator that Visa needs to be concerned with is consumer spending. The more people spend, the more revenue Visa makes. In the quarter ended March 31, the company saw no slowdown, despite headwinds from inflation, supply chain issues, the omicron variant, and the war in Ukraine. Payment volume, which is the amount of all the transactions on its network, went up 17% year over year. Cross-border volume rose 38%, while the number of transactions spiked 19% year over year.
Results for last quarter, Visa's fiscal Q3, are out on July 26, but it was a good sign that retail spending increased slightly in June, the month where we saw highest monthly jump in inflation in more than 40 years. And with a full recovery in travel spending, which is expected to exceed 2019 levels this summer, Visa should get a nice revenue boost from that market segment.
Visa and Mastercard are both solid buys right now, but I like Visa a little better because its margins are slightly higher, it has more cash on its balance sheet, and it has a lower debt-to-equity ratio. It also has a lower valuation, with a forward price-to-earnings ratio of 25, which is a bit less than Mastercard's. If the Federal Reserve can get inflation under control without causing a recession, Visa's outlook will be even better.
