The Dow Jones Industrial Average is well-known for its stability. The committee charged with making decisions about its makeup tends to be extremely conservative in implementing changes. Nevertheless, yesterday’s six-company switch in the Dow represented the average’s biggest shift since 2004, prompting investors to question whether the replacements really earned their place on the blue-chip index.
The addition of Visa Inc (NYSE:V) introduces a new element to the Dow. Although the average has had its fair share financial-industry stocks over the years, the way in which Visa makes money is fundamentally different from how banks and more traditional financial institutions earn profit. Moreover, with groundbreaking changes to the payment-processing business on the horizon, Visa Inc (NYSE:V) could look a lot different in the years and decades to come. Let’s take a closer look at the card company to see whether Visa Inc (NYSE:V) truly deserves to be in the Dow.
Credit without credit risk
The easiest way to tell that Visa Inc (NYSE:V) is different from most financial companies is to look at a chart of its performance during and since the financial crisis of five years ago. The card company certainly took its lumps along with most of the rest of the stock market, but in comparison to many of the banks that actually issue its cards, Visa Inc (NYSE:V) held up quite well and has posted strong gains during the ensuing recovery.
The reason is simple: Visa takes on no credit risk in facilitating card-based transactions. Bad lending practices and high default rates punished card-issuing banks during the crisis, but Visa Inc (NYSE:V)’s small cut that it collects through transaction-based merchant fees was never put at risk. The slowdown in spending activity during the recession hurt its transaction volumes, reducing its profit. But not having the potential for outright losses from operations gives Visa a fundamental business-model advantage over lending institutions.
Will Visa’s leadership last?
From an industry-leadership standpoint, Visa is the logical choice among card companies. According to Visa’s 2012 annual report, the card company had almost double the number of total cards issued that rival Mastercard Inc (NYSE:MA) offers, and both its payment volume and its total transaction volume have similar advantages. Moreover, Visa dwarfs current Dow member American Express Company (NYSE:AXP). Unlike Visa and Mastercard Inc (NYSE:MA), though, AmEx does issue its own cards and therefore does retain the credit exposure that produces so much of its profit.