Visa: A Speculative Buy

by The Compound Investor

The sheer amount of wealth creation generated from owning shares of the global payment processors is huge. I mean, just imagine if you had invested a $10k cash lump sum into Visa’s (V) initial public offering back in 2008. That stake is worth somewhere in the region of $100k at time of writing. Given the stock only IPO’d a decade ago, that works out to average annual returns of well in excess of 20%. Not too shabby at all for a blue chip stock.

What I find interesting about this is that this wealth creation has been entirely powered by earnings growth. This runs contrary to the idea that Visa stock has simply seen its valuation multiple expand massively. Relative to its IPO valuation, this is actually not the case at all as Visa’s EPS has grown at an average rate of 23% per annum over the past decade. On the flip side, there are two categories of risk here. First, we have legal and regulatory issues. Visa continues to rack up billions of dollars in cumulative fines because of competition issues. It also always seems to be on the cusp of fresh legal action or some regulatory probe from the powers that be. I don’t expect that to ever go away due to the fact that it acts as part of a ridiculously profitable oligopoly alongside Mastercard.

The second risk is technological. Who knows if, or when, something will fundamentally disrupt the current relationship between banks, merchants, consumers and Visa’s payment network? I don’t imagine this being an issue in the near future, but longer-term it is something to think about. In any case, those risks are worth it at the right valuation given the business converts half of its revenue into net profit every year.

Valuation

Visa stock currently trades for around $140, while analysts expect the company to earn $5.30 per share in FY19. Quick math puts the shares at around 26.5x annual earnings. Though it might not look it, I actually think that represents 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. Every single one of those stocks posted average annual EPS growth in excess of 10% between 1957 and 2003. Who in the late 1950s would have imagined those stodgy names would register so many years of double-digit profit growth? Very few I’d imagine. Visa could realistically match that performance assuming the risks above do not materialize.

Of all the stocks listed in the Dow Jones Industrial Average, I’d wager that Visa will register 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 during the intervening period. To put a precise number to it, you think that Visa stock will only trade for 15x annual earnings in the future. Now, in terms of annual returns that contraction represents a headwind of around 3.5% per annum when stretched over a fifteen-year period. That figure drops to 2.7% if you increase the outlook to 20 years. 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 annual shareholder returns for a very long time to come.

Note

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