I’ve been recommending Visa (NYSE:V) stock on this site going back to 2017. And Visa stock has been a strong choice. Shares have risen 125% over the past three years, more than tripling the return of the S&P 500.
Indeed, I’ve called V stock one to buy and hold for life. I’ve recommended it when it was expensive and when it got cheaper. And I bring those recommendations up not to pat myself on the back; like any investor, I’ve missed some calls as well. (Suggesting investors sell Shopify (NYSE:SHOP) at $139 probably is at the top of the list).
Rather, I mean to establish my bona fides as a long-term Visa bull. Because even as an investor who believes wholeheartedly in the Visa business, I’ll admit to some concern about the current valuation assigned Visa stock. At nearly 28x next year’s consensus earnings per share estimate, the stock is more expensive than it’s been since its 2008 initial public offering.
Of course, pretty much every quality stock is more expensive than it was 12 years ago — or even three years ago. That hadn’t been much of a problem until Monday. Investors who see the selling as an overreaction should stick with V stock. Everyone else, however, might see reason for caution.
Little Cause for Concern…
As far as V stock itself goes, the bull case is almost self-evident. Visa dominates the credit card industry, with over 40% market share globally in 2018. Mastercard (NYSE:MA) is a solid second in share, though still well behind.
As we move to a “cashless” economy, more and more transactions will run through Visa’s network. That amplifies the company’s exposure to macroeconomic growth in developed markets.
Meanwhile, the company continues to drive growth in developing markets: revenue in Central Europe, Middle East, and Africa rose a sizzling 22% in the fiscal first quarter, according to the most recent conference call.
This simply is a business that is going to grow for years. Valuation aside, it’s one of the best businesses in the entire market. And in this bull market, paying attention to the quality of the business, not the earnings multiples assigned the stock, has been the correct strategy.
…But Some Cause for Concern
That said, even after a nearly 5% decline on Monday, this is a stock priced for perfection. And it’s worth noting that fiscal first-quarter earnings weren’t perfect. A Wedbush analyst called the report “an unusually weak quarter” for Visa. The company forecast somewhat higher-than-expected client incentive payments in fiscal 2020 as well.
In fact, V stock fell after the Q1 release. Of course, as usually has been the case in this bull market, shares quickly recaptured their losses. But Monday’s plunge puts V stock below where it traded before the report.
Given the imperfect nature of the earnings release, that decline doesn’t seem illogical. And, again, even after Monday’s move the stock is expensive. A valuation of 28x forward earnings is one that typically was attributed to younger, smaller, growth stocks just a few years ago.
It’s a big multiple. It’s one that seems unlikely to expand much further. Of course, I said that in June, in arguing that while V stock was still a buy, investors needed to lower their expectations given valuation. V stock has rallied another 17% since then.
What Will Investors Pay for V Stock?
I’m tempted to reiterate that argument. It does seem unlikely that Visa stock can hold, say, a 35x price-to-earnings multiple. If there’s a ceiling on the P/E multiple, there’s somewhat of a ceiling on V stock.
To be sure, given double-digit annual earnings per share growth, V still can provide market-beating returns in that scenario. But this is a stock that’s soared, gaining 835% over the past decade. I’d, again, argue that investors have to expect returns will taper.
But at the end of the day, it may be the market, less than the business, that determines the V stock price, particularly in the near-term. We’re seeing that already, with V following the market down in the last three sessions.
And as with quality, high-priced giants like Microsoft (NASDAQ:MSFT), Mastercard and Nike (NYSE:NKE), there’s a reasonable debate to be had over valuation. It’s fair to wonder whether decelerating double-digit growth really can support a stock price that is 28x forward earnings and an even higher multiple to free cash flow.
At some point, investors will stop paying ever-higher multiples for quality, as they have for this bull market entering its 12th year. The big fear is that such a point has arrived — which will present a problem even for one of the market’s best stocks.
Vince Martin has been covering the financial industry for close to a decade for InvestorPlace.com and other outlets. He has no positions in any other securities mentioned.
