The level of wealth creation generated by holding shares of the global payment processors is huge. For instance if you had invested $10,000 in Visa’s (NYSE: V) initial public offering it would currently be worth somewhere in the region of $100,000. Bear in mind it floated in around 2008, so we are looking at annual returns of well over 20%. The interesting thing is that unlike other stock it has been entirely powered by earnings growth. Indeed per share profit has grown at an average rate of 23% per annum since 2008.
As far as I can see there are two categories of risk here. The first is entirely business related and the second is stock related. In terms of the former I like to think of Visa and MasterCard as being amongst the best speculative plays out there (a bit more on that below).When you have a business that converts half of its revenue to net profit every year then it is worth the risk at the right valuation.
That brings us on to the latter: the valuation risk. So far, Visa has managed to maintain a fairly rich price-to-earnings ratio because profit growth has been insanely strong. In its maiden year on the stock market Visa’s average P/E ratio was around 30x earnings. Right now Visa stock changes hands for around $140 per share and the business should earn $5.30 per share in its 2019 fiscal year (it runs from September to September). Crunch the numbers on that and it comes to a P/E ratio of around 26x earnings – not all that lower than where it was in 2008.
Though it might not look it I think that represents pretty good value. What makes me say that? Well, it comes back to Jeremy Siegel’s book The Future For Investors. Remember the list of the twenty best performing stocks of the last fifty years? It included the likes of Coca-Cola, PepsiCo, Philip Morris and Tootsie Roll Industries. Now, every single one of those stocks I just listed posted average annual earnings per share growth of over 10% between 1957 and 2003. How many folks in the late-1950s would’ve imagined those stodgy consumer defensives would register fifty years of double digit earnings per share growth? Very few.
I think the growth outlook for Visa could easily be comparable but for two potential banana skins. The first is litigation, which will continue to cost billions in cumulative fines because of competition issues. The second ‘unknown’ is technology. Who knows if, or when, something will fundamentally disrupt the current relationship between banks, merchants, consumers and Visa’s payment network. Again, at the right price that is worth the risk for a business as profitable as this.
Of all the stocks in the Dow Jones Industrial Average I’d wager Visa registers the highest rate of earnings growth over the next ten or twenty years. Let’s assume you take a conservative view of things and factor in some valuation contraction. In fifteen years time you think Visa will only trade at 15x annual earnings rather than 26x earnings. In terms of annual returns that represents a headwind of around 3.5% per annum over a fifteen year time frame. if you can stretch your outlook to twenty years then that figure drops to 2.7%.
On the plus side Visa’s business has the following going for it: a massive secular trend toward electronic payments from cash; a rising global population; stock buybacks and dividends. That could be worth double digit per annum earnings growth for a very long time to come.