Two stocks that seemingly have no limit to their upside are Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA). Every time you think a point of resistance has been reached, these two stocks blow through and trade even higher. But are these two stocks still a buy?
A Look At The Business
In the last three years Mastercard Inc (NYSE:MA) valuation has increased 180% and Visa Inc (NYSE:V) by nearly 160%. These large gains have been created as the global payment processing companies have expanded outside the U.S. and into new emerging markets. In the past, both companies earned the majority of their revenue in the U.S., but with the emergence of China and India, along with 150 other countries, growth and presence is becoming very balanced in this space.
Essentially, companies such as Mastercard Inc (NYSE:MA) and Visa Inc (NYSE:V) make their money when consumers use credit or debit cards. In terms of volume, credit is more than twice as significant as debit and is also growing faster. Both assessment and transaction fees make up most of the industry’s revenue, while service fees are less than 5%.
Are The Valuations Justified?
The belief that emerging market growth could lead to significant fundamental gains has pushed shares of both Visa Inc (NYSE:V) and MasterCard to gains that far exceed fundamental growth. For example, in the last three years, Visa’s revenue growth has been 50% total and Mastercard Inc (NYSE:MA) has been near 45%.
In my book Taking Charge With Value Investing (McGraw-Hill, 2013) I identify such trends where stock performance significantly outperforms fundamental growth as a major warning sign that a stock could reverse. This adds reason to the idea that MasterCard and Visa Inc (NYSE:V)’s valuation is mostly tied to upside potential, rather than current fundamentals.
As an investor, you must wonder if Visa or Mastercard Inc (NYSE:MA) can produce enough fundamental growth to ever validate their valuations. The payment processing segment is a high-margin business. Therefore, margins and P/E ratios should be discounted in favor of tracking top-line growth, due to margins already being squeezed near max.
MasterCard is currently trading at 9.5 times sales and Visa is trading at 11 times sales. Both ratios are a near 100% premium on their price/sales ratios three years ago. To me, this is yet another warning sign, which goes hand-in-hand with the idea of a valuation that far exceeds the rate of growth.
Are They Overvalued?
So, if Mastercard Inc (NYSE:MA) and Visa Inc (NYSE:V) can maintain their current rate of growth does it mean that both stocks are overvalued? In my opinion, the answer to this question is yes! Sure, there are emerging markets that are seeing high double digit GDP growth and are rapidly adding businesses that will accept Visa and MasterCard payment options, but this growth has been forecasted and priced into both stocks for the last two years; and is not expected to generate more than 5% revenue growth annually.