I thought I'd have a look at stocks operating in the credit services industry since American Express reported results on Wednesday. The credit services industry has several high growth companies which have been beaten up as investors shifted bias from growth to value. Now might be a good time to look at the industry to see how quality growth stocks are valued versus quality value stocks. Do keep in mind that I am looking for opportunities in the credit services industry: and the components of the industry can be quite different. This difference between industry components might seem like an apples to oranges comparison, but sometimes we cannot eat an apple and an orange. And at such times we have to compare an apple with an orange to decide which one we'd like to eat just now.
American Express is a large-cap stock with a market cap of $91.2 billion. So I thought I'd screen for large-cap companies (excluding mega-caps with a market capitalization of over $100 billion) in the credit services industry. And because the market has been weak in recent times, I asked the screener to display only those companies with reasonably strong quality scores. The screener then displays high-quality large-cap stocks in the credit services industry.
In the charts below you will find the output from a screener based on code I had first written a couple of years ago, thanks to a Twitter friend called Jack Barnes, which has been significantly improved by a gentlemen called Alan Stoll 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.
Source: Table 1: Alpha Omega Mathematica (Screener Coming Soon)
As you can see the top quality scores from amongst large-cap stocks in the credit services industry are SLM Corporation (NYSE:SLM), MasterCard (NYSE:MA) and American Express (NYSE:AXP). SLM Corporation is a very different animal from MasterCard or American Express, however, it does belong in the credit services industry: and that matters to an investor who is looking to allocate money to the industry.
From amongst the screened stocks, SLM Corporation offers the best value, with strong quality, and reasonable momentum. However, growth expectations are the weakest.
MasterCard offers the best quality and growth scores, together with the weakest value and momentum scores. Weak momentum is interesting at the present time because the recent shift in investor bias from value to growth has hurt growth stocks. And the value may not be quite as weak as it appears on a risk and growth adjusted basis.
American Express provides unexciting value, growth and momentum scores, with strong quality scores.
Let's have a look at some key value criteria for the three companies, in comparison with the market capitalization key criteria for the credit services industry.
Source: Table 2: Alpha Omega Mathematica
Everyone knows how to calculate the P/E Ratio: simply divide the price by trailing-twelve-month earnings. And if we are looking at the forward P/E ratio, simply divide the price by forward-year earnings. And on that basis, SLM Corporation is the clear winner, followed by American Express, and with MasterCard ranking last.
Since we are early in 2014, it might also make sense to look at the P/E Ratio based on current-year earnings expectations. Reuters Consensus estimates for 2014 are $3.05 for MasterCard (CY PE Ratio 24.23), $5.45 for American Express (CY PE Ratio 16.03) and $2.39 for SLM Corporation (CY PE Ratio 10.67). Based on current-year expectations, the best value is offered by SLM Corporation, followed by American Express and MasterCard in that order.
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.
We have a PEG Ratio of 1.59 for MasterCard, 1.19 for SLM Corporation and 1.67 for American Express. So here we have a change in rankings, with SLM Corporation still leading the way on a growth adjusted basis, but with MasterCard in second place ahead of American Express which comes in last. These PEG ratios are based on trailing-twelve-month earnings. If we use a PEG ratio based on current-year earnings expectations we get PEG ratios of 1.37 for MasterCard, 1.51 for American Express, and 1.48 for SLM Corporation. On a growth adjusted basis, based on current-year earnings expectations we have MasterCard leading the pack, with SLM Corporation coming in second and American Express bringing in the rear.
But there is so much more than just growth 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. I accept that beta and volatility may not be seen by many as a measure of risk. However, for better or for worse, beta pays an important role in investor return expectations: and investor expectations are what I seek to measure.
For MasterCard, SLM Corporation, and American Express, Finviz reports a beta of 0.93, 1.14 and 1.23, respectively. When we multiply MasterCard's PEG with beta, we get a P-RAGE Ratio of 1.48. When we multiply SLM Corporation's PEG with beta, we get a P-RAGE Ratio of 1.36. And when we multiply American Express's PEG with this beta, we get a P-RAGE Ratio of 2.05. So SLM Corporation leads the pack based on a growth and risk adjusted basis, followed by MasterCard in second place, and American Express coming in last.
The earnings expectations for 2014 do not look particularly aggressive, and we are now we are several months into 2014. Thus, it makes sense to review the P-RAGE ratio based on earnings expectations for 2014. Using the PEG Ratio based on current-year earnings expectations we get a P-RAGE ratio of 1.27 for MasterCard, 1.82 for American Express and 1.72 for SLM Corporation. The leader-board changes, with MasterCard leading, and SLM Corporation coming in second. American Express again comes in last.
From this I conclude that a value investor seeking to allocate money to the credit services industry would be drawn towards SLM Corporation, while a growth investor seeking to allocate money to the credit services industry would be drawn towards MasterCard. On a growth and risk adjusted basis, MasterCard is the top pick.
If you are a growth investor seeking to allocate capital to the credit services industry, you would do well to evaluate MasterCard versus Visa (NYSE:V), which falls in the mega-cap category, and so is not included in this post, though I have looked at it in an earlier post. In my view, Visa is the better pick.
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.