Visa: An Opportunity To Capture Growth Alpha

Apr.17.14 | About: Visa Inc. (V)


Visa has a PEG ratio of 1.45, compared with a market PEG of 2.64 and a financial service PEG of 2.51. Visa is cheap on a growth adjusted basis.

Visa has a beta of 0.80, compared with a market beta of 1. The P-RAGE Ratio (PEG Multiplied by Beta), which risk-adjusts the PEG Ratio, is attractive at 1.176.

The PEG for the credit services industry is 1.45 and beta 1.07. Thus, the P-RAGE Ratio for the credit services industry is 1.55, compared with 1.176 for Visa.

Visa offers 6.88% short-term alpha, after which it is priced to deliver a long-term return of 9.1%. On the other hand, the market is priced to deliver negative alpha.

I thought I'd have a look at mega-cap stocks with high growth expectations today. The screen rationale is as follows:

  1. We may be at the start of a bear market. And if we are, mega-cap stocks would be safer than smaller capitalization companies.
  2. If we are not in a bear market yet, there is an opportunity to profit from growth.
  3. Growth stocks have been beaten up in recent times. Much of the technical damage is done.
  4. There are reasonable odds that some growth companies which are perceived as expensive may represent good value.

In the charts below, you will find the output from a screener based on a code I had first written a couple of years ago, which has been significantly improved of late. It would help if you read about the build-out of that system here, as that will allow you to appreciate the model output later in this post better.

I'll hasten to add that this is a package aimed at generating ideas, it does not intend to, nor does it replace, the due diligence we must do as investors. It is a tool which uses quantitative techniques to understand the behavior of different market participants, and then brings that data together so that users can hear the voice of the market through the noise. The AOM system can guide you where to look, but make no mistake about it - it cannot look for you.

The Screener

Click to enlargeClick to enlarge

Source: Table 1: Alpha Omega Mathematica (Screener Coming Soon)

As you can see, the top growth scores from amongst mega-cap stocks with a market capitalization of $100 billion or more were Schlumberger (NYSE:SLB), Facebook (NASDAQ:FB), Gilead (NASDAQ:GILD), Visa (NYSE:V) and Amazon (NASDAQ:AMZN). I have done recent posts on all except for Visa, and so I thought it might be a good idea to present my views on the company.


After analyzing fifteen stock selection and capital allocation strategy combinations, the system assigns an AOM Score of 53% and an AOM Hold Recommendation for Visa.

The AOM Statistical scores (the next table on this post) for each of the fifteen strategy combinations are unique, and are not comparable with each other. The AOM Score is very different from AOM Statistical scores: it evaluates and rates the AOM Statistical scores for each of the fifteen strategy combinations, and uses a unique technique to make the statistical scores across the strategy combinations comparable. The output is the AOM Score: a quantitative assessment of the output from the fifteen strategy combinations. The AOM Recommendation is a plain-English recommendation based on the quintile the AOM Score falls in.

Source: Table 2: Alpha Omega Mathematica

AOM Statistical Scores

The AOM statistical scores are a statistical evaluation of thirty-eight key indicators for the company, grouped into value, growth, quality, and momentum categories. It illustrates how the key indicators for the stock perform in comparison to the market capitalization weighted scores for the market, the stock's sector and the stock's industry of operation. For Visa, the scores are strong for growth and quality, and weak for value and momentum.

Source: Table 3: Alpha Omega Mathematica

AOM Model Recommendations

The AOM statistical scores weighted differently for fifteen strategy combinations made up of five stock selection styles and three capital allocation styles, arrive at the AOM model recommendations. Visa is favored by people who use a growth bias in their stock selection strategy, particularly those who allocate capital at market or industry level. Growth investors who allocate capital at industry level would be neutral to Visa: growth investors interested in the credit services industry, with a higher level of risk tolerance, might want to consider a small-cap stock such as Consumer Portfolio Services (NASDAQ:CPSS). All other stock selection and capital allocation styles view Visa with utter neutrality.

Source: Table 4: Alpha Omega Mathematica

Growth Indicators

In the table below, you can see that Visa's key growth indicators have outperformed the market cap weighted key indicators for the market, the financial services sector and the credit services industry, in all but two cases. Quarter-on-quarter growth was slow in comparison with the market, sector and industry, while sales growth for the quarter was slow in comparison with the industry. This is a strong performance on the key criteria we use to assess growth.

Source: Table 5: Alpha Omega Mathematica

Value Indicators

In the chart below, you will see a selection of value indicators for each company, together with the market capitalization weighted scores for the market, the financial services sector, and the credit services industry. Visa is scored down against the credit services industry in all but one of the key indicators. The one saving grace is that the PEG Ratio for Visa is 1.47, in comparison with 1.45 for the credit services industry: the market capitalization PEG Ratio is very close to Visa's, and Visa's PEG Ratio wins versus the market capitalization weighted PEG ratio for the market and financial services industry.

Source: Table 6: Alpha Omega Mathematica

Everyone knows how to calculate the PE Ratio: simply divide price by trailing twelve month earnings. If we are looking at the forward PE ratio, simply divide price by forward year earnings. In the 1960s, a smart gentleman called Jim Slater realized that there is more to the math of the multiple, and he came up with the Price Earnings Growth Ratio [PEG]. This is a lovely ratio to use, because it brings the growth differential in as an investment consideration. It is simply the PE Ratio divided by the long-term growth rate expectation.

But there is so much more to the math of the multiple, that I wrote a post on it which you can read here. Now this is an awfully convoluted process, and people like simple: and simple works. What is missing in the PEG ratio is risk adjustment. I thought it might be worth multiplying the PEG Ratio by Beta to develop a P-RAGE ratio: that would be Price/Risk Adjusted Growth & Earnings Ratio. This ratio would simply multiply the PEG ratio by Beta to introduce an element of risk adjustment.

For Visa, Finviz reports a beta of 0.80. When we multiply Visa's PEG with this beta, we get a P-RAGE Ratio of 1.176. The market cap weighted beta for the credit services industry is 1.07. The credit services industry market cap weighted PEG is 1.45, and when we multiply it by the 1.07 market cap weighted beta for the credit services industry, we get a P-RAGE Ratio of 1.55. Thus on a risk and growth-adjusted basis, Visa is cheaper than the broad credit services industry.

I won't present the data for quality and momentum. You can view it here. The quality indicators for Visa are strong, while momentum is weak. The weakness in momentum is one reason I believe that Visa might represent a growth at a reasonable price opportunity. The P-RAGE Ratio gives me comfort that it is.

What is Visa worth

I will accept the Reuters consensus estimate of $8.88 for the year ended September 2014 as a reasonable estimate of sustainable earnings. I will use the Reuters long-term growth estimate of 18.10% as a reliable estimate of forward five year growth. I compute a very long-term growth rate of 7.38%, based on an assumption that growth will revert to being in-line with market growth rates of 6.25% in the sixth year. I estimate an adjusted payout ratio of 40% for Visa, made up of a dividend payout ratio of 15% and a further 25% returned to shareholders via buybacks, net of employee and other issuances. Assuming a long-term risk free rate of 4.5% and an equity risk premium of 5.75%, an investor in a stock with a beta of 0.80 should demand a return of 9.10%.

Mathematically, the worth of Visa is estimated as [1 + Long-term Growth Rate] * Sustainable Earnings * Adjusted Payout Ratio / [Long-term Return Expectation-Long-term Growth Rate]. Based on the assumptions set-out above, Visa is worth $222 [107.38% * $8.88 * 40% / (9.1%-7.38%)]. Visa recently traded at 207.70. This provides an opportunity to capture $14.30 (6.88%) in alpha. Once the price target of $222 is reached, there is no long-term alpha available. However, a long-term return expectation of 9.1% will be satisfied: and that is not bad, considering that the market is currently pricing considerable long-term negative alpha potential.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.