The financial services industry has been grabbing headlines lately, and not exactly for the right reasons. The recent collapse of SVB Financial sent shockwaves throughout the sector. Perhaps that's a bit unfair. The issues that plagued SBV Financial were self-inflicted and are unlikely to affect larger, well-established banks. Still, for investors looking for exposure to this industry but unwilling to get into the complex and, on occasion, risky business that banking is, here is one option to consider: Visa (V 0.33%).
Visa avoids one risk that banks face
Millions of credit cards in circulation are branded with Visa's logo. So it's natural to think the company issues these cards to customers. But that's not the case. Visa is merely an intermediary between the financial institutions that issue credit and the merchants that sell to cardholders. Visa simply provides a platform that transfers payments from customers' banks to merchants' banks, taking a small fee on every transaction.
On the one hand, that means Visa does not make any money on the interest banks charge their clients on credit card balances. But there is also a significant advantage to the company's business model. Namely, it is not subject to the possibility that some customers will default on their debt, also known as credit risk. Let's not forget that too many people defaulting on their housing loans played a significant role in the 2008 financial crisis, so this is no small thing.
A collapse of 2008 magnitude is unlikely to happen again. Governments and financial institutions put safeguards in place to ensure it wouldn't. The point, though, is that individual banks still face credit risk while Visa doesn't. That's an advantage in the latter's favor. Investors seeking to avoid this fundamental risk in banking, while still having money invested in the lucrative financial services industry, can opt for Visa.
Visa's robust profit margins
There is another crucial aspect of Visa's business that investors should consider -- namely, its wide profit margins compared to leading banks, or for that matter, most other corporations of comparable size. The chart below pits the company against several of the largest financial institutions in the U.S. in this category.
Data source: YCharts
Why are Visa's margins so juicy? Because the company's payment network is already established, and each additional transaction goes almost entirely to the bottom line while increasing the company's operating costs very little. That's yet another point in Visa's favor.
Still a long way to go in this industry
The banking business won't go away anytime soon, nor will Visa. Although the company has been around for a while, playing a role reducing the use of cash, there is still a long way to go. In January 2022, Visa Chairman and Chief Executive Officer Alfred Kelly said:
While cash displacement is certainly a reality, global personal consumption expenditure of cash and check grew at a [compound annual growth rate] of 2% over the 10 years ending in 2019. When we look at the opportunity ahead, if you assume global cash grows at 1% annually, industrywide digital penetration of personal consumption expenditure wouldn't reach 90% for several decades.
Visa could continue growing in these decades as more transactions switch from cash and checks to electronic payment. The result will be a higher processed volume for the company and growing fees.
Here's one key reason Visa is almost certain to remain one of the leaders in this industry: The company benefits from a network effect as more merchants and consumers increase use of its service.
The more customers plug into its payment network, the more attractive it becomes to merchants, and vice versa. This dynamic partly explains why Visa and Mastercard have maintained a duopoly in this market.
Visa is a table-pounding buy
SVB Financial going under does not mean investors should avoid the financial services industry. Visa is an excellent option because its business model avoids an important risk banks carry, boasts higher margins, and still has an ample growth opportunity in its market. All those factors make Visa a solid buy for those worried about bank stocks -- or even for investors who aren't worried at all.
