Don’t Chase Visa or MasterCard Any Higher

You'll be overpaying at a time when the payment technology space is clouding up

   
Don’t Chase Visa or MasterCard Any Higher

Credit card giants MasterCard (NYSE:MA) and Visa (NYSE:V) both crushed earnings estimates this past week, and both are sitting at new all-time highs.

Not bad, considering the line of work they are in. Given that the global economy has been tepid at best lately and that unemployment remains stubbornly high, you might not expect great performance from companies that depend on consumers opening their wallets.

But by focusing narrowly on the consumer angle, you miss the proverbial forest for the trees. MasterCard and Visa — along with American Express (NYSE:AXP) and, to a lesser extent, Discover Financial (NYSE:DFS) — are some of the prime beneficiaries of two of the most powerful macro trends of the past 20 years:

  1. The transition to a global cashless society
  2. The rise of the emerging-market consumer

The first point should be obvious. Even in the United States, where credit and debit cards are ubiquitous, roughly 40% of all transactions are conducted with cash or paper checks. Not all transactions will ever be captured with credit and debit cards, of course, but with Internet commerce growing relative to “bricks and mortar,” you can bet that percentage will grow.

Demographics also play a role here. Older consumers who might never have embraced plastic are a shrinking segment of the population, whereas anyone under the age of 50 grew up with credit cards and anyone under 30 learned how to swipe a credit card before they could walk.

I exaggerate … but not all that much.

Card usage also is working its way down the economic ladder. Consumers without access to traditional credit or banking services are embracing prepaid cards branded with the Visa and MasterCard logos, and both companies are experimenting with ways to let consumers pay at retail cash registers using their mobile phones.

Even American Express, which has traditionally focused on a more patrician business clientele, has partnered with Walmart (NYSE:WMT) in promoting its Bluebird prepaid cards.

This is a long way of saying that even if overall consumer spending growth is tepid, growth in electronic payments has plenty of room to grow.

The second point is the one I find the most promising, however. Credit and debit card usage is soaring in virtually all major emerging markets as incomes rise and consumers join the ranks of the global middle class. Rising incomes and growing financial sophistication can only mean a higher percentage of transactions move from cash to plastic. Both Visa and MasterCard stand to benefit from this trend, though Visa has the better presence globally. Visa expects to get more than half of its revenues from overseas by 2015, and the overwhelming amount of this will come from emerging markets.

So what’s the downside?

As I see it, there are two. The first is competition from other mobile payment solutions such as eBay’s (NASDAQ:EBAY) PayPal and Square.

It gets a little muddy here, however. PayPal is a payment mechanism in of itself, but it is also a facilitator for payment with a traditional credit card. Up until this point, the mobile revolution has been nothing but beneficial for the traditional credit card companies. The card readers for Square and PayPal here turn any Apple (NASDAQ:AAPL) iPhone or Google (NASDAQ:GOOG) Android device into a mobile point-of-sale terminal. Even an ice cream man or hotdog street vender can take payment by card now.

But this is also a fast-changing area, and there is a possibility that Visa and MasterCard can see themselves getting pushed out as unnecessary middlemen. On my recent visit to Home Depot (NYSE:HD), the cash registers gave me the option to pay with PayPal. Today, this is a novelty. But in five years, will it be the norm?

Maybe, maybe not. But given the rate of change in this space, I am reluctant to pay too high a premium for the stocks in this sector. The growth is impressive and the profit margins are so high as to be absurd. But as with any investment, you don’t want to overpay.

And this brings me to the second downside. Both MasterCard and Visa sport valuations that are reminiscent of the 1990s tech bubble. Visa trades for an absurd 50 times trailing earnings and 21 times expected 2014 earnings. MasterCard, at 25 times trailing earnings and 18 times forward earnings, almost looks reasonable by comparison.

Almost.

As much as I like both companies, I’m not comfortable paying these prices. For now, I’d recommend you pass on Visa and MasterCard.

In the card sphere, American Express would appear to be the best bargain. Unlike Visa and MasterCard, AmEx actually accepts credit risk, but I am OK with that. In an improving economy, that is not such a bad thing. AmEx trades for 13 times expected earnings and pays a 1.2% dividend.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management.  As of this writing, Sizemore Capital was long WMT. Click here to receive his FREE 8-part investing series that will not only show you which sectors will soar but also which stocks will deliver the highest returns. The series starts November 5 and includes a FREE copy of his 2014 Macro Trend Profit Report.


Article printed from InvestorPlace Media, http://investorplace.com/2013/05/dont-chase-the-credit-card-stocks-mastercard-visa/.

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