The credit card is back. After a brief hiatus following the 2008 financial crisis in which debit card use outpaced credit card use, it appears that credit is back on top. According to First Data, a major card processor, growth in credit card usage has outpaced growth in debit card usage in 2011, including the post-Thanksgiving shopping orgy we call Black Friday.
After the 2008 meltdown — a crisis that was caused from an excess of debt — consumers “got religion” for a while, cut up their credit cards, and chose to live within their means by using debit cards tied to their bank accounts. But ironically, the Dodd-Frank financial reforms — ostensibly rammed down the banking industry’s collective throat to protect us from the evils of irresponsible lending and borrowing — made credit more appealing than debit for banks and consumers alike. The Durbin amendment to Dodd-Frank limited the revenues that banks could earn from issuing debit cards, leading some to charge monthly fees to consumers for debit card use. Not too shockingly, in many households the debit cards got cut up and the credit cards came out of the desk drawer.
Only in Washington D.C. could a law intended to encourage responsible financial behavior lead to an increase in credit card use.
As investors, it doesn’t pay to fret about politics. Instead, we should simply follow the money to see who best stands to benefit. We’ll start by looking at the two dominate card companies: Visa (NYSE:V) and MasterCard (NYSE:MA).
Visa and MasterCard are well positioned to profit from two powerful macro trends:
- The shift to a global cashless society
- The rise of the new emerging market middle class
Every year, a larger percentage of purchases are made using plastic. In many U.S. cities, even the taxi cabs take credit cards. So whether the boom times return or we sink back into recession, the revenues of the major card companies should continue to grow. The explosive growth in internet commerce will only accelerate this.
There will always be some demand for the anonymity of cash, and the paper check will continue to be with us for a while. But the march towards electronic payments is inexorable.
As is the rise of the emerging market consumer. In much of the world outside of America and Europe, a large percent of buying and selling is done in cold, hard cash. Given the long history of banking crises and government confiscation, many emerging-market consumers prefer to keep their savings out of the bank and under their respective mattresses.
Or at least they used to. As living standards rise and millions of consumers join the ranks of the middle classes, there is a growing preference for electronic payments. And this trends isn’t going to be reversed anytime soon.
I’m somewhat partial to Visa, as the stock has been one of my best-performing recommendations of 2011. And barring a dramatic turn of events, Visa will also be the winner of InvestorPlace’s “10 Best Stocks for 2011” contest.
But with respect to the debit / credit issue in the United States, MasterCard finds itself in a better position. MasterCard has a much larger percentage of its card portfolio in credit rather than debit. Still, it’s hard for me to choose one over the other; both are high-growth, high-quality companies backed by unstoppable macro trends. And as investors, we don’t have to choose. We can own both, and that is exactly what I recommend you do.
Another option might be to go with credit-only card issues American Express (NYSE:AXP) or Discover (NYSE:DFS). With no exposure to debit cards, these two would seem to have nothing to lose and everything to gain from a shift in consumer preference for credit over debit.
Investors need to do an extra layer of analysis on these two, however. Unlike Visa and MasterCard — who make money by processing transactions and take no credit risk — American Express and Discover are banks and come with all the risks inherent in that industry. Furthermore, as the premier business card, American Express is more closely tied to the state of the economy than Visa or MasterCard. And Discover, as the smallest player in this game, faces a brutal competitive environment.
This is not to say that either is unattractive, per se. American Express is the closest thing to a “luxury good” in the card universe, and Warren Buffett likes the company enough to make it a core holding of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). And Discover is easily the most attractively priced of the group at just 7 times earnings and 2 times sales. Discover also has a large student loan portfolio, and tends to target younger consumers with short credit histories. This is a positive during boom times but a disaster during busts.
If you are a conservative investor betting on long-term trends, stick with Visa and MasterCard. But if you believe that the U.S. economy will significantly improve in 2012, American Express and Discover are both likely to outperform their non-credit-risk-taking rivals. Just hope that the Occupy Wall Street crowd doesn’t persuade Discover’s college student customers to revolt!
Disclosure: I am long V.