BY:  Chuck Carnevale, CIO of EDMP, Inc.

Visa and MasterCard Deserved a Higher Price

Introduction

Both Visa, Inc. (V) and MasterCard, Inc. (MA) enjoyed explosive moves in their stock values on Wednesday, June 29, 2011.  Visa was up over 15% and MasterCard over 11% thanks to the Fed’s more liberal-than-expected stance on debit fee regulations.  In our opinion, this perceived regulatory overhang had caused the share prices of these consistent and powerful earnings generators to sit below their intrinsic value.  Therefore, we believed that the Durbin Amendment, although problematic for both Visa and MasterCard, would be less impactful to their long-term business opportunities than their low stock prices indicated.

The true value investor understands the importance of fundamentals over short-term market action.  In The Intelligent Investor, Ben Graham taught us why it was important, and also, how to be an intelligent patient investor.  The father of modern security analysis, and the dean of value investing, focused first on analyzing and determining the intrinsic value of a business.  Then, only after completing this vital and most important task, would he look to see how the market was currently valuing the business.  Mr. Graham summarized this important principle with his famous quote that I reference often:

“In the short-run, the market is a voting machine;
In the long-run, the market is a weighing machine.”

The most important point which we are trying to articulate is that it is not possible that the True Worth™ value of multibillion-dollar enterprises could change by as much as 15% in one single trading day.  Either the market was wrong the day before this happened, or it is wrong now that it has happened, or as we believe, the market is wrong on both days.  Volatility at extreme levels can only be thought of as irrational behavior.  Accepting the idea that the stock market can misprice a common stock at any time is an attribute that prudent value investors possess.  Therefore, they are empowered to exploit the folly when it manifests.

Visa and MasterCard by the Numbers

The following earnings and price correlated F.A.S.T. Graphs™ on Visa (V) and then MasterCard (MA) illustrate several important points regarding the valuation of their stocks on June 28, 2011, one day before the powerful advances referenced above.  Both companies had been able to generate consistent above-average earnings growth right through the recent trying economic times.  Nevertheless, both companies experienced historically low stock price valuations in spite of their excellent operating records.  In other words the only thing that was down was their price.

 

visa stock price versus peg ratio
click to enlarge
mastercard earnings and pe ratio
click to enlarge

 

 

The Difference a Day Makes

It’s interesting to look at the earnings and price correlated F.A.S.T. Graphs™ on these same companies, only one day later.  Clearly, although the stock prices have dramatically risen, they still remain below each company’s historical normal PE ratio (the blue line on the graphs).

 

visa price over book
click to enlarge

The Future

The following estimated earnings and return calculators reveal the current consensus five-year estimated earnings growth of 32 leading analysts reporting to FirstCall.  Even though both companies enjoyed explosive stock price activity on June 29, 2011, they both remain attractively valued based on expected earnings growth.

 

modeling mastercard financial statements
click to enlarge
visa future model of balance sheet
click to enlarge

 

Thesis for Growth

Both Visa (V) and MasterCard (MA) are global leaders in electronic payments.  We believe that each of these dominant franchises possess almost impenetrable wide moats.  Both companies have built networks of thousands of financial institutions throughout the world on their strong brand identities and reputations.  We believe it would be almost impossible for a newcomer to duplicate either companies’ scope or scale.  Furthermore, both of these companies continue to invest heavily in their brands, thereby both widening and deepening their respective moats.

Both Visa and MasterCard have strong balance sheets with virtually no debt and each generates solid and growing cash flows.  Consequently, each possesses the financial strength to continue building their brands and funding future growth.  As the world continues moving toward cashless electronic payments, both companies have ample room for growth.  The Federal Reserve’s recent decision to liberalize the interchange fee limit proposed last year has removed a perceived major risk.

Perhaps the greatest remaining risk to either of these franchises relates to lawsuits alleging anti-competitive practices.  Therefore, prospective investors are encouraged to conduct their own due diligence.  Fortunately, the investor relations sections of both of these companies’ websites provide comprehensive presentations of each companies’ business models and growth prospects.  We would encourage prospective investors to take advantage of these informative resources.

Conclusions

We believe that Visa, Inc. (V) and MasterCard, Inc (MA) represent two companies with strong historical records of growing earnings, and that both possess bright prospects for continuing that growth.  We also believe that the market has been unrealistically pricing their stocks below their intrinsic values based on inflated fears of government intervention.  Now that that intervention has been somewhat mitigated, both companies’ stocks soared off of their low levels.  However, we believe that both companies remain attractively valued today, although not necessarily undervalued any longer.

Long V, MA at the time of writing.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.