MasterCard And Visa: 2 Buffett Style Toll Bridges For Everyone's Portfolio

| About: MasterCard Incorporated (MA)

Summary

A comparative quantitative analysis using a unique free cash flow ratio.

Explains why both companies should be long term holdings in every investors portfolio.

Explains why both are Duopolies that can be classified as Buffett style "Toll Bridges".

On January 31, 2017 Seeking Alpha's News Editor Charles Schultz reported the following: MasterCard lower after revenue miss

MasterCard (NYSE:MA) beat Wall Street estimates by $0.01 and missed on revenue estimates by a small fraction, of about $30 million. A $30 million miss on revenue of $2.76 Billion comes out to -1.09%.

But if we move on from that point and look at the actual results, we will find that the company actually had a very strong report, especially when you consider that it is reporting in US dollars and that the US Dollar Index during the last quarter rocketed upward.

Then when you factor in that MasterCard deals in 150 currencies, it becomes mindboggling to think of what management had to go through in order to deal with the incredible volatility that the currency markets endured over the last quarter. As reported by MasterCard, the value of transactions made by card holders outside the home country of the card-issuer, increased 13 percent and that the company processed more than 65,000 transactions every minute. That resulted in its gross dollar volume of transactions going up 9 percent to $1.2 trillion on a local currency basis.

MasterCard also reported that it was dealing with a higher tax rate this quarter on a year on year basis, as its PowerPoint below shows.

The effective tax rate was 28.7% vs. 13.1% for the same comparable quarter in 2015, turned out to be a serious headwind, which MasterCard was able to overcome.

After seeing this slight miss on revenue from MasterCard, investors may now start to worry about the company's main competitor Visa (NYSE:V) and how it may do when it reports on February 2, 2017?

In this article, I will present a real-time quantitative analysis of both companies employing a unique ratio that will demonstrate the power of free cash flow in the investment process and then give an opinion on how an investor should act based on my results.

When analyzing almost any company, concentrate on its free cash flow generation, as that is where the rubber hits the road when it comes to finding out the truth. Before I show you the long-term Datafile for MasterCard, let us first do a TTM (trailing-twelve month) analysis of its Bernhard Buffett Free Cash Flow and then compare it to its current price.

Here are the two ratios that we will be using in our analysis, and for those new to this type of analysis, one can get a good introduction by reading my analysis of Apple Inc. (NASDAQ: AAPL) by clicking here.

Price-to-Bernhard Buffett Free Cash Flow Ratio = Sherlock Debt Divisor/ [(net income per share + depreciation per share) + (capital spending per diluted share)]

Sherlock Debt Divisor = Market Price Per Share - [((Working Capital - Long-Term Debt)/Diluted Shares Outstanding)]

MasterCard

Market Price Per Share = $109.30

Working Capital = Total Current Assets - Total Current Liabilities

Total Current Assets = $11,776,000,000

Total Current Liabilities = $7,121,000,000

Working Capital = $4,655,000,000

Long-Term Debt = $3,326,000,000

Diluted Shares Outstanding = 1,099,000,000

Sherlock Debt Divisor = Market Price Per Share - ((Working Capital - Long-Term Debt)/Diluted Shares Outstanding))

Sherlock Debt Divisor = $109.30 - (($4,655,000,000 - $3,326,000,000)/ 1,099,000,000))

Sherlock Debt Divisor = $109.30 - $1.21 = $108.09

Since MasterCard has less Long-Term Debt vs. Working Capital, we therefore must reward it and use the $108.09 result as the new numerator in all our calculations.

Price-to-Bernhard/Buffett Ratio = Sherlock Debt Divisor/ [(net income per share + depreciation per share) + (capital spending per diluted share)]

Sherlock Debt Divisor = $108.09

Net Income per diluted share = $4,016,000,000/1,099,000,000= $3.65

Depreciation per diluted share = $1,207,000,000/1,099,000,000= $1.09

Capital Spending per diluted share = $-208,000,000/1,099,000,000 = $-0.19

$3.65 + $1.09 + ($-0.19) = $4.55

Price-to-Bernhard/Buffett Free Cash Flow Ratio = $108.09/$4.55 = 23.76

Now if you go to my Friedrich Legend (on what is considered a good or bad result), you will notice that our result of 23.76 is an average result.

We last ran our Datafile for MasterCard on January 31, 2017, and our Friedrich Algorithm gave a recommendation to our subscribers to hold it.

Here is the chart of our Price-to-Bernhard Buffett Free Cash Flow ratio results for MasterCard:

The Price-to-Bernhard Buffett Ratio considers a stock a bargain when it trades under 15 times and overbought when it trades over 30 times. Therefore, from the current results in the chart above, MasterCard comes in as a "HOLD".

Let us now compare those results to its main competitor Visa.

Here is our Price-to-Bernhard Buffett Free Cash Flow Analysis for Visa.

Visa

Market Price Per Share = $83.70

Working Capital = Total Current Assets - Total Current Liabilities

Total Current Assets = $14,313,000,000

Total Current Liabilities = $8,046,000,000

Working Capital = $6,267,000,000

Long-Term Debt = $15,882,000,000

Diluted Shares Outstanding = 2,414,000,000

Sherlock Debt Divisor = Market Price Per Share - ((Working Capital - Long-Term Debt)/Diluted Shares Outstanding)

Sherlock Debt Divisor = $83.70 - (($6,270,000,000 - $15,882,000,000)/ 2,414,000,000))

Sherlock Debt Divisor = $83.70 - ($-3.98) = $87.68

Since Visa has more Long-Term Debt vs. Working Capital, we therefore must punish it and use the $87.68 result as the new numerator in all our calculations.

Price-to-Bernhard/Buffett Ratio = Sherlock Debt Divisor/ [(net income per share + depreciation per share) + (capital spending per diluted share)]

Sherlock Debt Divisor = $87.68

Net Income per diluted share = $5,991,000,000/2,414,000,000= $2.48

Depreciation per diluted share = $502,000,000/2,414,000,000= $0.21

Capital Spending per diluted share = $-523,000,000/2,414,000,000= $-0.22

$2.48 + $0.21 + ($-0.22) = $2.47

Price-to-Bernhard/Buffett Free Cash Flow Ratio = $87.68/$2.47 =35.50

35.50 is considered a poor result for this ratio, but the reason Visa's numbers came in so poorly is because it recently merged with Visa Europe and it had to take special charges due to the merger. Our analysis is done with GAAP results and not Pro Forma, so we do not adjust, but report "as is". The deal is a win-win for both companies as the merged company will have the following stats going forward:

"Visa Inc and Visa Europe are united again. The combined company provides digital payment products, services and processing to about 17,100 financial institution clients and partners, 40+ million merchant outlets, and three billion Visa accounts worldwide.

The company says its branded cards and payment products amount to approximately $6.8 trillion in global payments volume annually."

Thus, an investor in Visa needs to ignore the latest GAAP one-time events and wait to pass judgment once the merged Visa's financial results are presented. Until then the company's results look overvalued, but should dramatically improve, once we get the updated figures from the company.

Going forward, I am looking forward to when Visa reports, so I can get the additional data from the newly merged company. MasterCard had an excellent report, when you adjust for the year on year higher tax rate comparison. Each is experiencing legal problems as governments tend to try and fine successful firms, simply because government officials can't seem to believe that MasterCard and Visa can be as successful as each is and thus believe that there must be something wrong somewhere? That is why MasterCard and Visa have an armada of lawyers protecting them from such harassment. Both companies are very long term (if not permanent holdings) in my client portfolios, as I consider both to be Buffett style "Toll Bridges" and I love to invest in such companies. The future for both companies is very bright, so I sleep well owning them for my clients.

"The now famous "toll bridge" reference to investing was made famous by Warren Buffett. This is not to say that you should literally invest in a toll bridge, but rather in the type of investment that works much like one. They make great growth investments when you can find them at the right price. As the name implies, if you are heading down a toll bridge or road, and you come to the toll stop, you must pay it. And if this bridge or road makes life easier for folks, well, you can expect them to pay the toll on a regular basis."

In conclusion, it is my belief that free cash flow analysis is the ultimate tool when analyzing companies, and my hope is that you may add these ratios to your own investor tool box in order to help you in your own due diligence. If you have any questions, please feel free to ask them in the comment section below and don't forget to hit the "Follow" button after our Friedrich Research username on top as we plan to do many more comparative case studies like this one in the near future.

Disclosure: I am/we are long MA, V, AAPL.

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.

Additional disclosure: DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from our research. Factual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.

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