Let me get one thing out in front: Visa (NYSE: V)
is a phenomenal company. I mean really, really good. High-quality.
Strong moat. Well-managed. Sturdy balance sheet. The works. It's the
epitome of what you should look for in long-term investments.
Alas, Visa's stock scares me silly. Why? Amid all the happy things
you can say about the company, it's easy to overlook two important
Before you send that hate mail, let me explain.
Crazy for cards
To gauge investor sentiment on Visa's future, I pulled up analysts' earnings expectations for the next four years. Have a look:
Source: Capital IQ, a division of Standard and Poor's.
This is pretty serious stuff. On average, it's an expectation of
17.4% annual growth, based upon predictions that Visa -- along with
rival MasterCard (NYSE: MA)
-- will ride a global shift from paper to plastic commerce. These
assumptions are also based on a business model that accepts no credit
risk. Unlike American Express (NYSE: AXP) or Discover (NYSE: DFS),
Visa simply makes money off transactions -- an inherently safe and
lucrative business model. It's great work if you can get it.
And investors know this. They're so confident, in fact, that shares
have been bid up to more than 24 times this year's earnings, and more
than 20 times next year's.
Think about that for a moment, tend to your nosebleed, and
acknowledge this point: Yes, earnings are expected to skyrocket, but
shares are valued at a level that entirely reflects this. Growth --
even tremendous growth -- is already priced in.
Hence, meeting these lofty expectations will likely result
in less-than-awesome returns. Here's a simple example: Say Visa meets
2011 earnings expectations of $3.95 per share, and still commands a
multiple of 20 times earnings. Under these assumptions, it'll reward
shareholders with annual returns of less than 8% per year -- nothing to
sneeze at, but nothing to drool over, either. You can pick apart the
assumptions all you'd like, but you'll be hard pressed to come up with
anything that's both rational and spectacular. That's just the nature of stocks priced for perfection.
Here's where things get exciting
Now, curious investors will read the above and ask a simple question: What happens if things don't go as planned? What if growth doesn't
materialize as investors imagine? This is smart thinking. Expectations
of assured and unremitting growth are almost invariably wrong. Anyone
alive over the past two years can relate.
And with Visa, let me be blunt: I think the hype over its supposed explosive growth in the coming years is spectacularly overblown.
Why? Glad you asked.
As we speak, banks like Citigroup (NYSE: C), Bank of America (NYSE: BAC), and JPMorgan Chase (NYSE: JPM) are slashing credit card lines like their lives depend on it. One estimate
tags this number at $2.7 trillion by 2010, which equates to the
evaporation of 60% of the dollar amount of extended credit. The era of
consumers' attachment to credit cards is simply toast.
This point is sometimes pooh-poohed by those who note Visa's
dominance in debit transactions. Debit, they insist, will pick up where
credit left off.
This is true to a point. But perspective is in order. While debit
gets all the attention, credit is still responsible for around
two-thirds of total payment volume. Some might argue that payment
volume isn't the end-all profit driver, and that the number of
transactions -- where debit is still king -- matters, too. This is
true. But this source of revenue, called data processing fees,
represents only 33% of total revenue, compared to nearly 50% captured
by service fees, which is tied to payment volume.
Credit is still a main factor in Visa's bottom line, and that
division is -- and will be -- weighed down by consumers adjusting to
frugality and banks pulling credit lines. This point should not be
ignored. It's big. It's real. And it's dangerous for investors to
overlook. The growth expectations for which this stock is priced seem
out of touch with the credit card industry's ongoing paradigm shift.
Excitement, meet caution
Again, let me
reiterate: I think Visa is a top-notch company. It really is. But there
seems to be a disconnect between the odds of faltering and the odds of
perfection. Even if my fear of credit annihilation is totally
misguided, shares are still priced at levels that won't let
investors fully capitalize on Visa success. Any way you spin it, I
don't see how you can be excited about these prices.
Copyright © 2009 Universal Press Syndicate.