Although past results don't necessarily predict future returns, we can look back to figure out how things might fare moving ahead. With this perspective, Visa (V -0.23%) could continue to outperform.
In the last decade, the payments company has seen its shares rise nearly fivefold, a gain that crushes the S&P 500. Can this financial stock continue its unstoppable track record in the next few years?
Dominating the payments landscape
Visa makes money by collecting fees from merchants when they accept one of the company's branded credit or debit cards. Unlike the banking institutions that issue those cards, it extends no credit, thus eliminating default risk from the business model. It simply provides the communications infrastructure that helps facilitate transactions.
The business has proved to be very lucrative, with the company's operating margin averaging 66% over the past five years. And Visa's tremendous scale shows how dominant it is: Fourth-quarter 2023 total payments volume was $3.8 trillion with a 61% market share in the U.S. (based on dollar value of its transactions).
The business benefits from the increasing popularity of digital transactions, which in many cases are more convenient and safer than cash or checks. In the U.S., many Americans still use cash for a meaningful portion of their spending. So even in the most developed economies, there's still a sizable runway for growth. This trend should continue, meaning Visa's payments volume will keep rising over the next five years.
The threat of fintech enterprises
Visa needs to be able to handle the intense competition that it's constantly facing. This is true of any business in any industry, but perhaps it's even more pronounced due to how much innovation and change are happening in payments at any given moment.
Luckily, Visa has been in a favorable position for a long time because of the company's wide competitive moat. This sustainable advantage has allowed it to produce impressive financial performance in the past.
In particular, I'm talking about the company's network effects. Visa operates a two-sided platform that connects 4.3 billion of its cards with over 130 million merchant locations. Add in the fact that it is accepted in more than 200 countries and territories and handled 276 billion transactions in fiscal 2023, and it shows how crucial the business is to the smooth functioning of the economy. This gives me confidence that Visa's competitive position is under no threat, at least for the next five years.
Skeptics might point to the rise of fintechs over the past decade, like PayPal, Block, Adyen, and Stripe. While all of these companies have found tremendous success in one way or another, I don't believe they should necessarily worry Visa shareholders.
In fact, they provide the services and tools that can help accelerate digital payments and cashless transactions, which could help Visa over the long term.
Factoring in valuation
Although the valuation is extremely important to investor returns, it's impossible to know what it will be in five years. That's because market sentiment is changing all the time. Moreover, the valuation that stocks trade at is heavily influenced by interest rates, which themselves are unknowable.
Visa shares currently trade at a price-to-earnings ratio of 32.8, a discount compared to the stock's trailing five-year average. For our purposes here, let's just assume that shares command the same multiple in five years that they have right now.
And if we also expect diluted earnings per share to rise at a 13% annualized clip over the next five years (slightly lower than they have in the past five years), then investors would also generate that same double-digit return.
This forecast makes Visa stock seem like a no-brainer buy for long-term investors.
