At first blush, Visa (NYSE:V) may look a tiny bit on the pricey side. At the current price of exactly $217.00, Visa has produced $8.13 in profits per share for a P/E valuation of 26.7x earnings. Although that may seem expensive, Visa does offer quite a good deal when you think in terms of reasonably expected cash flows that the credit card company should generate, and move beyond an undue focus on its current earnings yield.
I'll give an example to show you what I mean. In 2010, Visa's stock sailed upward from $65 to $97 per share. It could have been easy to look at that 49.2% percentage increase, and immediately conclude that the price of the stock had gotten ahead of itself. At the time, Visa was making $3.91 in profits per share. It could have been easy to look at that 25x earnings valuation, mixed with the 49.2% price increase, and conclude that Visa was too expensive to merit investment consideration.
But here is where things get interesting. Visa has the kind of business model in place that makes it possible to justify the lofty valuation. Here we are in 2014, and Visa has been making $8.13 per share. Imagine what things would look like now, within just four short years of initiating your position. Compared to that $97 purchase price in 2010, the current $8.13 in profits are only 11.93x greater than earnings. The growth in Visa's profits have been so rapid that the pricey-ness of the valuation rapidly gets demolished.
Generally, Benjamin Graham's margin of safety concept applies to finding a high present earnings yield because you don't have to rely on future growth to make the investment successful. And there's a lot of wisdom in that approach. But it is not the end all, be all; your total returns consist of the combination of not only current profits but future profits as well, and if you can find a company that has a high likelihood of growing profits by north of 10% annually for an extended period of time, then you can do quite well for yourself by accepting a slightly lower starting yield.
Instead of worrying about Visa trading at 26x earnings, the more appropriate focus of inquiry would be this: How likely is Visa to continue growing profits in the neighborhood of the 15% annual range?
My answer would be this: very likely. Its margins are absurdly high because the company has little capital investment, and is able to participate in organic growth without having to make commensurate investments (i.e. once your local McDonald's is equipped to handle Visa payments, the company doesn't have to invest any more money when 500 customers come through the door compared to 200). The operating margins are between 61% and 63% per year, and the return on equity figure remains at slightly north of 18%.
Outside of the United States, the company is growing profits at 20% annually, as the company has a growth rate of over 30% per year in the Asian Pacific regions. That mixes with a growth rate of around 8% in the United States, and a buyback program funded out of cash flow that is on pace to retire 25-30 million shares per year. Once you accept that nothing is guaranteed in life, those look like promising leads for a company to be growing north of 10% by a meaningful amount.
And there is the matter of the company's dividend, which doesn't get a whole lot of attention because the starting is 1%. That's understandable. But if you have a broad perspective, it can be useful to keep in mind that the dividend has been typically growing by between 20% and 30% each year, because Visa is playing catch-up on its low payout ratio that it has had since its IPO in 2008 when the company only paid out 5% of profits to shareholders (that figure has since climbed to 18% of profits). Dividend investors are in the unique position where they can experience both an increasing payout ratio for a company that is also growing profits by 15% annually which can lead to very interesting results down the line.
The real question you should be asking is: What will Visa be making five or more years from now, and how certain am I of that happening? Take the current analyst consensus of $16 per share for 2019. Even if the company's valuation came down to 20x earnings by that time, you are still looking at a price of $320 per share plus whatever dividends you receive over that time frame. The only time it makes sense to accept a high initial P/E ratio for a stock is if the company is poised to grow earnings significantly and you believe there is a high probability of that coming to fruition. Visa is one of the few companies left in this market that fits the bill.
Disclosure: The author is long V. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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