The Pink Portfolio: Mastercard's Growth

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About: Mastercard Incorporated (MA), Includes: V
by: From Growth to Value
Summary

The Pink Portfolio is the real-life portfolio that I have set up for our 5-year old daughter. I have added Mastercard to the Pink Portfolio.

Mastercard has been a ten-bagger over the last decade. That doesn't mean that it cannot go on being a great investment, though.

The company benefits from several tailwinds, such as betting, e-commerce, international expansion, and its B2B segment.

Although Mastercard may seem expensive, because of its growth, it is always a good buy.

The Pink Portfolio has done very well so far, and it beats the market substantially.

Introduction

In May 2016, I started up the Pink Portfolio for our little girl. She was almost 2 years old back then, and she has become 5 on June 11. The system is quite simple: my wife and I add $150 per month to her portfolio and buy stocks with it. I focused mainly on dividend stocks in the beginning, but I have started adding growth stocks too and plan to add more.

The last update that I have written is from June 2019, when I added PayPal (NASDAQ:PYPL). In this article, I report about a new stock I have added to our daughter's portfolio: Mastercard (MA).

Quick summary

A quick summary for those who don't have much time to read the full article:

  • Mastercard and Visa (NYSE:V) have a duopoly and have both been ten-baggers over the last decade.
  • Mastercard's share price is up 54% YTD.
  • The company has an attractive dividend. Although in dividend yield, it shows just a tiny 0.46%, the dividend growth has been very attractive and is a real bonus for long-term investors.
  • There are several catalysts for the company to keep growing. It has tailwinds from several secular trends like online betting and e-commerce growth, and these trends will only continue. The current low interest rate environment benefits the company as well.
  • Inside the company, international growth and B2B payments look like great opportunities and are growing faster than the legacy card business.
  • Despite the fact that it has a trailing P/E of 44.58 and a forward P/E of 31.70, Mastercard is a great stock to add to your portfolio.
  • Despite the moderate overvaluation, the stock could return 9% yearly over the next three years and much more if you hold longer.

A short introduction to Mastercard

I am sure you all know Mastercard and its core products. The Purchase, New York, based multinational has a current market cap of $285.47B. Its bread and butter is, of course, traditionally processed payments between the banks of merchants and the banks of their customers. But it does a lot more these days. The company itself says that it is 'connecting consumers, financial institutions, merchants, governments and businesses in more than 210 countries and territories.'

Mastercard $MA Mastercard payment technology credit cards

(Source)

It also states:

Our mission is clear:

Every day, everywhere, we use our technology and expertise to make payments safe, simple and smart.

A winning duopoly

Coca-Cola (KO) vs. Pepsi (PEP), Home Depot (HD) vs. Lowe's (LOW), Boeing (BA) vs. Airbus (OTCPK:EADSF) (OTCPK:EADSY). Duopolies can be hugely profitable and often both companies (and both stocks) do very well. And that rule also goes for Mastercard and Visa.

This is what Mastercard and Visa have done since Visa's IPO in 2008 (Mastercard's IPO was in 2006):

Chart Data by YCharts

As you can see, the patient investor has been rewarded by buying-and-holding both stocks. Both are ten-baggers and have beaten the S&P 500 index by a huge margin of more than 1,000%. But the less patient or more recent investor has had a lot to be happy about as well. This is what Mastercard has done YTD:

Chart Data by YCharts

If you are a dividend investor or looking for capital appreciation, Mastercard has got both. Although the typical dividend investor will look down on the paltry 0.46% dividend yield, that low yield comes from the high price appreciation. Mastercard's dividend has multiplied by more than 35 since its IPO in 2006:

Chart Data by YCharts

Despite the huge dividend raises, because of the stellar stock performance, the dividend yield has always been lower than 1%, though:

Chart Data by YCharts

Mastercard's payout ratio has always stayed very low too, almost all of the time under 20%:

Chart Data by YCharts

For the Pink Portfolio, with such a long-term investment horizon, it would be shortsighted, in my opinion, to buy dividend payers like Altria (MO), AT&T (T), Macy's (M) or even Coca-Cola (KO). Yes, they still raise their dividends, but they don't grow their earnings (enough) to keep their pay-out ratio at the same level or lower. That is not a good strategy over the long term. If I take dividend stocks for a portfolio with such a long investment horizon, I want high dividend growth, combined with high earnings growth and a low payout ratio. Mastercard perfectly fits into this mold. But to each his own, of course.

This is the dividend history of Mastercard:

(Source: Seeking Alpha)

As you can see, Mastercard has only a streak of 8 years of dividend raises. I expect the company to keep boosting its dividend by mid-teen percentages going forward, although it may be higher. The last dividend hike was a huge 32% (from $1 to $1.32 annually). Besides that, the company also installed a new share repurchase program of $6.5B, to boost shareholders' return even more.

The company is still firing on all cylinders on the earnings side as well and you can see that in its most recent Q-10:

The diluted earnings per share in the first six months of 2019 went from $2.91 to $3.80, an increase of more than 30%.

Tailwinds

Mastercard and Visa both benefit from the low-interest-rate environment. They have lower rates because their cost to borrow money sinks, but their own APRs stay as high as ever, averaging 17.8% now.

A lot of consumers nowadays turn away from plastic cards, although the issues of Square's (SQ) and Apple's (AAPL) recent cards might suggest otherwise.

Cash Card Square stock shift Multibagger Visa Mastercard (Square's Cash Card, source)

Apple card investing Mastercard

(The Apple Card, source)

But that doesn't mean that Mastercard or Visa become obsolete. They thrive in the new environment by adapting to new technological payment methods. Cash and checks are the big losers in the new era, and Mastercard can benefit from the transition. While Square's Cash Card works with Visa, Venmo's (PYPL) card works with Mastercard. Those two examples alone of arguably the two hippest payment apps available now show that both Mastercard and Visa will benefit from the cashless society.

Venmo card Mastercard cool colors Visa app stock portfolio investing

(Venmo card, source)

A lot of the apps that are supposed to make Visa and Mastercard obsolete work with one of the two big systems and so they enable them to grow even faster. You can see that on this slide:

(Q2 2019 earning slides)

While the cards grew 6% YoY, not bad in any way, the star here is the switched transactions. These are the transactions that use Mastercard's software. It enables an interface (an ATM, POS, mPOS, etc.) to get the authorization from hosts such as your bank. Switched transactions grew 18%, and that is where the biggest growth will come from going forward too.

Another important factor in Mastercard's growth is the globalization of the Mastercard system. The growth internationally is actually higher than in the US: 14% GDV growth in the rest of the world versus 10% in the US.

(Q2 2019 earning slides)

As you can see, the international GDV (gross dollar revenue) is more than double as big as the American. This diversification is a good thing for Mastercard since it makes it less vulnerable for national recessions. On the other hand, since the company reports in dollars, there are always fluctuations because of the many currencies that Mastercard deals with. You can see that on this slide that the currency-neutral growth for Q2 2019 was actually bigger than the reported growth in dollars:

(Q2 2019 earning slides)

Mastercard still develops its international pipeline. It has partnered with Angaza in February of this year to roll out a digital payment solution in emerging markets. Angaza removes the upfront costs for essentials like solar panels, cooking stoves, water pumps and other off-grid necessities in emerging markets like Uganda, India, Kenya, Malawi, Nicaragua, Pakistan, Sierra Leone and others. Because of this collaboration, Mastercard can dig the new oil of this digital era: data. The data of the unbanked in emerging markets are very hard to get, but this is certainly a way to do it.

Of course, online shopping, another tailwind for Mastercard, won't fall anytime soon too. It is expected to keep growing at a healthy pace. This is a projection of Statista:

online shopping CAGR evolution stocks Mastercard bookings

Another growing market is online gambling. Mordor Intelligence expects that it will grow at a CAGR of 8.77% over the next five years:

online gambling CAGR Mastercard stock investing

On May 14, 2018, the Federal Court removed the ban on sports betting. In a lot of states, sports betting is already legalized, and about all of the others are expected to follow soon. Only 8 states have not done anything yet, by which I mean legislation or pending legislation, to facilitate sports betting.

The B2B services of Mastercard are a fast-growing segment too. Mastercard assists businesses streamlining and digitizing their payment processes in order to increase speed and security. This is a big market, and Mastercard has only started, and there remains still a lot of opportunities here. This is the answer Mastercard's CFO Sachin Mehra gave to analyst Bob Napoli's question about B2B on the last earnings call:

So our B2B business, Bob, as you know, you should think about as things we've been doing for many, many years on the commercial side, catering to the small business universe, the T&E side of the business, our fleet card management side of the business, that business continues to grow well. There still remains a lot of opportunity from a secular shift standpoint, I would tell you, in that part of the business. We continue to grow that nicely. We've got some very solid platforms, which you're familiar with, which support the growth of that commercial business.

The company doesn't split up this growing B2B business in its reports, but it is mixed with other initiatives, such as data, under 'Other revenues'. That category grew by 23% in the last quarter, even 24% on a currency-neutral basis.

Valuation

Mastercard is expected to earn EPS of $9.03 next year, according to finviz.com. That means that, while it has a high ttm P/E of 43, its forward P/E of 31 is somewhat more moderate. Despite the big rise in Mastercard's stock price in 2019, its P/E is actually lower than in 2018:

Chart Data by YCharts

With an expected earnings growth of 18.36% next year, the company trades at a 'forward PEG' of 1.69. In my opinion, that is not that expensive for a premium company.

I think the low-interest environment we live in warrants Mastercard's higher multiple. Besides that, Mastercard is expected to have a CAGR EPS growth of 16.86% over the next five years according to finviz.com. That would mean the following for the valuation for the coming years:

Year EPS P/E
2020 $9.03 31.18
2021 $10.55 26.67
2022 $12.33 22.82
2023 $14.41 19.53
2024 $16.84 16.70

(Compiled by the author)

And, this is just for five years. If you are a true long-term investor, you'll hold on for much, much longer. And probably, Mastercard will top the expectations, as it has almost always done. Look at this impressive track record:

Mastercard earnings beating beats $MA surprise

Mastercard earnings beating beats $MA surprise

(Source: streetinsider.com)

36 earnings results, 34 beats (a whopping 94.4%), 2 hits and just one single miss. That is really impressive! That also says to me that management knows very well how to navigate this business towards success and that it will probably continue its great streak for years to come.

Despite the higher multiple, the stock could still return above 9% yearly over the next three years if the stock returns to its normal P/E multiple of 29, according to FAST graphs:

Of course, any stock price could drop by, let's say, 40% or so in the next recession, but if you hold Mastercard shares for the long term (which is in my book at least a decade), you will probably have both high price appreciation as dividend growth.

A lot of investors are afraid to invest in stocks like Mastercard because they always look overvalued. I used to be one of them. But if you look at the real long term, valuation matters much less. For the Pink Portfolio, with its investment horizon of at least 20 years and probably much longer, this means that I don't have to look at the valuation all that much.

With all that potential under the hood, I thought Mastercard was an excellent addition to the Pink Portfolio. The stock has done extremely well over the last decade, and with the secular trends that it has as a tailwind, I expect that Mastercard will keep outperforming the market.

The Pink Portfolio: An overview

As a whole, the Pink Portfolio beats the S&P 500 based on percentage points:

Stock performance performance S&P Alpha
NKE 47.88% 41.43% +6.45%
DIS 39.68% 40.77% -1.09%
AAPL 94.21% 34.04% +60.17%
SBUX 78.88% 34.99% +43.89%
VFC 53.18% 23.77% +29.41%
HAS 6.74% 18.23% -11.49%
ATVI -23.16% 10.88% -34.04%
MTCH 80.77% 3.79% +76.98%
TWTR 10.29% -0.39% +10.68%
PYPL -5.20% -1.09% -4.11%
TOTAL 383.27% 206.42% 176.85%
Average 38.3% 20.6% 17.7%

The Pink Portfolio beats the market by an average of 17.7% since its inception. While this is a fun exercise, these numbers just show the return from the beginning. Some stocks have done better since I have added at lows, others have done about the same. Since I considered all positions as very valuable stocks for the long term, I don't mind that much for temporary underperformance.

Just a remark before we go to the current state of the Pink Portfolio. As you might know by now, our girl's birthday is in June. But because of our, erm, let's call it inertia, we only have deposited the birthday money of her grandparents and our extra contribution in July. With the $150 of July, the extra birthday money and the $150 in August, I was able to buy two shares already, which excites me. This is how the Pink Portfolio looks like now:

Pink Portfolio stocks for children portfolio for child investing from birth

(Source: Compiled by the author; price = current price, purchase is average price of the several purchases per stock, cost is the cost of the broker, div py is dividend per year, prices: closing price August 30, 2019).

As you can see, $150 per month (with extra bucks for birthdays and Christmas) can grow to a substantial amount. The total worth of the Pink Portfolio is already over $10,000 now. That is in just a bit over 3 years, with a small amount each month. That is the power of compounding!

A few remarks:

  • I have used the dividends when I needed them to purchase an extra share along the way, not specifically of the same stock.
  • I still consider all stocks as great stocks going forward.
  • I intend to keep diversifying the portfolio with more stocks.

Takeaway

Even with $150 per month, you can make a great portfolio. I will keep adding money to the Pink Portfolio, and I intend to update you of every new purchase or on special occasions. I have added Mastercard to the Pink Portfolio because of the long-term potential of double-digit growth for years to come.

If you want to see how the Pink Portfolio keeps growing, please push the "Follow" button.

In the meantime, keep growing!

Disclosure: I am/we are long DIS, MTCH, MA, PYPL, SBUX, AAPL, VFC, HAS, TWTR, NKE, ATVI, SQ. 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.