With a trailing five-year return of 88% (as of Sept. 19), Mastercard (MA -0.75%) shares have outperformed the S&P 500 and the Nasdaq Composite Index during that time. That momentum has continued in the past three- and six-month periods as well. Those strong gains could entice some investors to add this winner to their portfolios.
Strong financials and economic moat
Shares have performed so well in the past because of Mastercard's impressive financial performance. Revenue growth has averaged more than 12% between 2017 and 2022. But even more exciting is the operating leverage inherent in the business model. Because processing every additional transaction on the payments network has almost no cost, Mastercard has been able to increase its bottom line at a rapid clip. Diluted earnings per share in 2022 totaled $10.22, a huge improvement from $3.65 in 2017.
The key to this solid growth momentum is the ongoing secular trend of cashless transactions and digital payments. Consumers love using their credit cards thanks to the perks and benefits offered, as well as the added convenience of not having to carry lots of cash around. Cash is still a popular way to complete transactions not only in the U.S. but in many parts of the world. This means Mastercard has a lot of growth potential.
Mastercard also benefits from powerful network effects, as a result of its 3.2 billion active cards and the tens of millions of merchants that accept them as payment. I'd bet that the vast majority of people reading this article have at least one Mastercard-branded card in their wallet. The fact that they are accepted everywhere creates valuable convenience. And to not lose any potential sales opportunities, merchants need to accept them. That's certainly a strong competitive position to be in.
Key bear arguments
Businesses that dominate their respective industries tend to become the target of regulatory action, and this is the case with Mastercard. The company has had to pay sizable fines in the past due to its market power. And more recently, the Credit Card Competition Act of 2023, which requires big banks to use a card network that isn't Visa or Mastercard, is intended to increase competition in the space. If this becomes law, it could lead to lower fees for merchants, which could result in less revenue potential for Mastercard.
While the U.S. and other developed economies are ahead of the curve when it comes to cashless transactions, there are emerging-market countries that have greater growth potential for a business like Mastercard. But what is a clear risk is that major economies, like China, favor local payment networks over the global card giants. In the Asian nation, UnionPay is the dominant network for card transactions. And in India, RuPay is a home-grown network that competes directly with Mastercard.
These countries might decide to enact more restrictive measures to make it more difficult for outside networks to find success, which could cap Mastercard's potential in some potentially lucrative markets.
In my opinion, Mastercard is one of the best businesses in the world, despite the bear arguments I just outlined. However, the current valuation isn't cheap. The stock trades at a trailing price-to-earnings ratio of 38.8, which is above the trailing 10-year average and about 25% more expensive than rival Visa. That might give some investors pause.
I think there are two ways to look at this. It might still be a smart idea to add shares to your portfolio given Mastercard's stellar history of financial success, which will likely continue. On the other hand, perhaps it's best to keep the stock on your watch list for now and wait for a better entry price. It all depends on how much you prioritize valuation.
