Rule Makers rule. If a portion of your portfolio isn't dedicated to owning the world's most dominant franchises over the long haul, you're probably missing out on some of the lowest-stress, lowest-cost, and most tax-efficient returns the market has to offer.
So when my Foolish colleague Joey Khattab asked me to select a specific Rule Maker-ish company to highlight, I just had to chime in with First Data (NYSE:FDC) -- a stock of mine I've never had to fuss about.
The advantages of day trading
The ideal Rule Maker is a company whose products or services are bought every single day by millions of people all over the world. Think Wrigley (NYSE:WWY) with chewing gum, Starbucks with coffee, or Procter & Gamble with, well, just about everything in your home.
Although less obvious, First Data -- which profits from the billions of dollars' worth of credit card and debit transactions taking place on a daily basis -- also fits that description pretty well.
We encourage investors to take 10 key steps in determining whether a company should be called a Rule Maker. Below, I'll go through some of the more important ones and explain why First Data deserves to be included in the Rule Making nomenclature.
The company must have at least one competitive advantage.
First Data's main advantage is its sheer size. It is the undisputed champion of payment processing, handling upwards of 20 billion transactions in North America each year.
First Data essentially processes 50% of the credit card and debit transactions in the U.S., while its closest competitors, Bank of America (NYSE:BAC), US Bancorp (NYSE:USB), and Fifth Third Bank (NYSE:FITB), own about 16%, 8%, and 7% of the market, respectively.
Since payment processing is largely made up of fixed costs, First Data is able to leverage its massive size to attain significant cost advantages over its competitors. This huge competitive edge, in turn, leads to whopping free cash flow generation, high returns on invested capital, and a solid financial position for First Data and its shareholders -- three more critical factors of Rule Making companies.
Soaring sales and growing revenue
Fortunately, First Data dominates a market which also happens to be exceptionally profitable and growing healthily. No buggy whips or sewing machines here.
According to estimates, about $7.4 trillion in payments will be made in the U.S. in 2008, up from $5.6 trillion in 2002. Also, card-based transactions should represent nearly half of all U.S. payments in two years' time, up from about one-third in 1997.
This environment has helped First Data generate more than $6 billion worth of sales for the past five years, while growing those revenues at an average rate of 13%. Although the spinoff of Western Union (NYSE:WU) will surely ease this rate of growth, First Data should still be able to grow in the double-digit range, as it benefits from the long-term trend toward plastic payments.
A reasonable purchase (or holding) price
As we all know, even great companies can make lousy investments if the purchase price is too high. This shouldn't be too much of a concern with First Data at today's levels.
The stock trades at a P/E ratio of 13, while many of its lesser competitors are trading at price multiples above 20. Heck, even the industry average (an industry which First Data dominates, remember) has a higher P/E at 14.
Of course, if discounting cash flows is more to your liking, my own quick-and-dirty valuation (which uses an 8% discount rate, conservative growth estimates, and a seven-year holding period) tells me First Data is selling at a pretty reasonable price, also.
The Fool's final rule
It's important to note that the 10 Rule Maker Steps shouldn't be taken as hard and fast laws. Given different sets of industries, it's important to remain flexible.
The point of the Rule Maker philosophy is to own dominant franchises with awesome economics, attractive growth opportunities, and rock-solid balance sheets. As long as the price is right, excellent businesses represent the main reason individual investors should be in the stock market.
Given those characteristics, First Data is clearly a Rule Making company that any Fool should at least consider as a core investment.
Now go back and read about the other contenders for the best Rule Maker. For more stock ideas, visit Motley Fool Inside Value, where we identify industry leaders trading for bargain prices. Try Inside Value free for 30 days.
Fool contributor Brian Pacampara thinks he makes the rules, but his Pharaoh Hound, Raubia, is always proving him wrong. He owns shares of First Data. First Data and Western Union are Motley Fool Inside Value recommendations. Starbucks is a Stock Advisor pick. Bank of America, US Bancorp, and Wrigley are Motley Fool Income Investor selections. The Fool's disclosure policy is the strict set of rules that always rules Fools.
