Like seemingly every other stock in this market, Visa Inc (NYSE:V) has been red-hot in 2017, with V stock up nearly 40%. Visa, along with Mastercard Inc (NYSE:MA), were two of my favorite long-term holdings, but these big runs — MA stock is up even more — have left me in a bind. After years of owning these stocks and only adding to my position on significant, short-term pullbacks, I began paring back this year. In hindsight, of course, I regret it. V and MA have only found their way higher, working off overbought conditions with consolidation rather than price declines.
In fact, Visa and Mastercard were part of my Future Blue Chip holdings. While the dividends are low now, these companies are raising their payouts by double-digit percentages. The plan is to cement these high growth stocks in our portfolio at a low price and collect larger dividend payouts years and decades into the future.
So What Went Wrong With the Plan?
Without a 5% pullback in more than a year or even a 3% correction in almost eight months, one would have thought some sort of decline would materialize. My selling will certainly draw criticism, I’m sure. Remember, though, Visa Inc stock price is up more than 200% over the last five years. It’s not as if I was taking profits on a 10% move and looking to buy on a 2% pullback.
I certainly want to own more V and MA again, but these are expensive stocks. Sticking with Visa stock specifically, shares are now trading with a trailing price-to-earnings (P/E) ratio of 40. Its forward P/E ratio stands at 27. It trades at more than 13 times sales. Because it has such wide margins, much of its revenue trickles down to the bottom line. That’s why its sales multiple is so high, but it’s earnings multiple is comprehendible.
Analysts expect earnings to grow 21% this year, with 20% sales growth to go along with it. Impressive numbers no doubt. In 2018, analysts expect that growth to slow to 16.5% and 10%, respectively. I get that we pay a premium for strong brands and consistent earners — I have for years! But at what point is that premium too much?
Visa’s price-to-sales (P/S) multiple is at its highest level ever. Operating margins have plateaued in the mid-60% range, while profit margins are actually down over the trailing 12 months. V stock has a five-year average P/E ratio of 32. The current P/E ratio is 25% higher than this average. A return to the mean valuation would drop shares of Visa stock from $107 to $86. I’m not saying it will fall that far, only that’s where it would be based on its average P/E ratio.
The U.S. and global economy is stronger. It now controls Visa Europe. The transition from checks and cash to credit and debit remains bright. There’s all the reason in the world to believe that Visa and Mastercard will continue to benefit through the end of the decade and longer. V deserves a premium, no doubt, but it was already valued with a premium before this year’s huge ramp.
Should I have seen that the market wasn’t going to blink and that the cream of the crop would continue to rise? Probably. But I’m not perfect. So we have a stock near peak margins (historically speaking) and at its highest sales multiple with a deceleration in earnings and revenue growth in 2018 trading at 40 times earnings.
I’ll take my chances waiting.
The Bottom Line on V Stock
At some point, the U.S. markets have to correct. They always have and likely always will (unless the machines completely take over!). This earnings season doesn’t seem like it will be the catalyst and a year-end rally wouldn’t be a surprise. But at some point, stock will come down.
Will I end up buying Visa stock and MA back near my average selling cost? Maybe. But that’s the way it goes sometimes. These are long-term winners with a secular tailwind at their back. They deserve a premium, but I think this premium is a bit too much.
While many never seem to see the pullback coming, keep in mind that in late-2015, the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) was at $205 on Christmas. Six weeks later it was at $186. Amazon.com, Inc. (NASDAQ:AMZN) fell almost 30% from $675 on Dec. 31 to $475 by early February. V stock and MA stock both sustained double-digit percentage declines.
I’m not predicting this will happen at the same time. But just know that keeping some cash on the sidelines can be beneficial for these swift and sometimes violent corrections.