When people talk about beating the stock market, they generally mean the S&P 500, an index of 500 of America's biggest and brightest companies. However, perhaps investors should begin referring to the Nasdaq Composite Index.
The Nasdaq holds more than 3,700 stocks, all listed on the Nasdaq stock exchange, and it has produced remarkable results, outperforming the S&P 500 by a wide margin over the past 10 years.
That said, there is a dividend stock that has trounced the Nasdaq over that time. I'll show you its performance history and explain why investors can expect more of the same in the coming years.
Meet this market-beating juggernaut
Payments company Mastercard (MA 0.07%) should be well-known among investors. There's a good chance that you have seen its red and orange logo on a debit or credit card in your wallet, especially if you're American. The Mastercard branding notes that payments made with those cards run on Mastercard's network.
You could think of using a payment card as similar to a telephone call. You pick up a phone and call your Aunt Sally across the country, and there is a network of telephone lines that connect you to her, carrying data back and forth (your voices). Swipe a payment card, and the merchant is essentially dialing the bank or lender that backs your card to verify you have the money for the transaction and to authorize taking it. The payment network connects merchants to financial institutions to make this happen.
Data source: YCharts
Mastercard charges the merchant a small percentage of the transaction as a fee, which is how it generates most of its revenue. Payment cards and digital wallets have exploded in popularity, decreasing cash's use as a payment method. Years of growth have fueled Mastercard's stock returns and helped it trounce the Nasdaq.
Mastercard's strengths will fuel its dividend growth
Charting Mastercard's financials over time helps underline how strong a business it is. For starters, Mastercard has become increasingly profitable because the business's revenue increases faster than its expenses. The company turns $0.45 of every revenue dollar into cash, which is tremendous when you do $24 billion in annual revenue.
Additionally, Mastercard achieves a remarkable 52% return on invested capital. That's another way of saying that it generates a significant return on every dollar it puts into the business. The combination of growth and an efficient business model has created so much cash that it's begun flowing back to shareholders.
Data source: YCharts
Mastercard is a dividend rock star in the making; the company has raised its dividend 12 years and counting, and the payout ratio is still just 21%. At the same time, Mastercard has repurchased enough stock to lower its share outstanding count by 41% over the past 10 years. Reducing the share count boosts per-share profit, which ultimately helps push the stock price higher over time. That's a big factor in the stock's impressive performance.
Why market-beating returns could continue
Ultimately, the question is whether Mastercard can keep this up. To figure that out, investors should look at the company's growth outlook and the stock's valuation. Over the next several years, analyst estimates believe Mastercard's revenue will increase at a low-double-digit percentage pace and earnings will rise by 19% annually on average. Mastercard benefits from inflation because it charges a percentage of each transaction. In other words, inflation carries transaction values higher, which flows to Mastercard as fee revenue.
That should continue powering rising cash flow, so investors should look for more share repurchases and dividend increases in the future. The stock trades at a forward P/E of 31 today. Based on earnings forecasts, that works out to a PEG ratio of just over 1.6, signaling the stock is reasonably priced.
Data source: YCharts
Investment returns are always more difficult to project in the short term because the market is unpredictable. However, growth and strong financials often shine over time, and Mastercard has the ingredients to continue putting up strong returns over the coming years. Long-term investors can confidently buy Mastercard; it's a great business trading at a very fair price.
