Time to Capitalize on QE3: Visa Inc (V), Mastercard Inc (MA)

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The Phillips curve attached below, explains the short term inverse relationship between inflation and unemployment. However, over the longer run it suggests that the unemployment rate will pull back to its natural value if inflation rate is kept constant. But it’s not constant!

As a result of $40 billion worth of monthly liquidity injections, jobless claims recently touched their 5 year lows. But just as its effects started to wear off, Fed decided to inject $45 billion of additional monthly liquidity. This would definitely add to the country’s inflation, meaning which, the unemployment rate could continue to decline. This would further boost the disposable income in the economy which eventually presents a bullish case for credit services companies like Visa Inc (NYSE:V), MasterCard Inc (NYSE:MA)American Express Company (NYSE:AXP) and Discover Financial Services (NYSE:DFS).

The Numbers Game

But American Express and Discover Financial don’t just service retail payments. American Express is a global bank, which makes it hard for the company to deliver skyrocketing returns, similar to its other indirect peers. However Discover Financial has been able deliver similar returns, due to its relatively smaller size and series of geographical expansions. As a matter of fact, Discover Financial entered the booming Indian market, less than a year ago. The company hasn’t been involved in any mass advertising campaigns, which suggests that its growth potential in India has largely been untapped.

(comparative stock returns over the last 5 years)

The chart attached below, displays that the operating cash flows and liquid positions of Discover Financial have declined, but its liabilities have more than doubled over the last 5 years. The picture begins to look gloomy, until we add its net income to the chart. With strong net income growth, its high debt/equity ratio looks okay. Discover Financial is a growing company, and it needs capital to expand, which justifies its leveraged position.

(Key trends of Discover Financial Services (NYSE:DFS) – 5 year chart)

Reasons to Buy Visa and MasterCard

But Discover Financial also carries risks of Non-Performing-Assets or student loan defaults. Investors looking to avoid such risks should consider investing in MasterCard and Visa, even though they don’t appear to be undervalued. Both Visa Inc (NYSE:V) and MasterCard Inc (NYSE:MA) operate with little or no debt, involve less risk on transactions and their EPS is expected to grow faster than Discover Financial or American Express. Just because their P/E is above 15x doesn’t mean that the opportunity is lost.

Company Forward P/E Debt/Equity Net Profit Margin 5yr EPS growth est.
American Express 11.69x 326% 13.26% 10.78%
Discover Financial 8.72x 205% 30.64% 10.67%
MasterCard 17.17x 0% 37.32% 17.83%
Visa 18.19x 0% 22.46% 18.57%

For the recent quarter, Visa reported record revenues of $2.85 billion, rising 12% YoY against the estimated 10.7%. Its EPS rose by 22% due to onetime tax benefits, and its operating income stood at $2.85 billion against the estimated $2.82 billion. The street was already impressed and to add to the investors delight, the company raised its FY13 FCF guidance to $6 billion. The company already has a $1.5 billion share repurchase program, which would boost its EPS and reduce its dividend burden.

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