It’s not often a company like Visa comes around. Visa is a relatively new public company, despite being in existence for almost 50 years and being one of the biggest brand names in the world. At the time, its 2008 IPO was the largest in US history.
It’s one of those companies that always seems like it’s overvalued because it’s always trading at a high P/E multiple. Early in my investment days I looked at the high P/E and the low dividend yield and dismissed it as an investment. In doing so I learned an important lesson. Sometimes high quality companies deserve to trade at high valuations.
A general rule I follow is that it is almost impossible to maintain high-teens to low-twenty percent EPS growth over a long period of time. People see that kind of profit growth and they want a piece. And for the past decade, Visa has been making money hand over fist. They’ve grown EPS 19% annually over the past decade. That is an incredibly impressive number. You’d be hard pressed to find any company with that kind of earnings growth over 10 years, much less a company the size of Visa. So how is Visa able to produce those impressive earnings? It has the impressive trifecta of high barriers to entry, low operating cost, and built-in inflation protection.
The payment processing industry is not a very crowded place. Visa, MasterCard, Discover, and American Express virtually run the show. PayPal and a slew of startups are trying to break the business model, but have not had much success in taking share from the big 4. People love the convenience and rewards that come with major credit cards.
The reason it is unlikely another player will surface in the transaction processing space in the near term is twofold. Building out a payment processing network is not cheap. A startup can’t just come in tomorrow and build a processing network with the coverage and robustness of the big 4. Perhaps more importantly, retail owners don’t want new players. They are already peeved enough about the 3% processing fees they have to pay.
While building out a payment processing network is costly, once it is deployed ongoing maintenance costs are very low. Think of it like any other computer network. Once everything is up and running, electricity is the main cost.
Built-in inflation protection is hard to find. Visa’s fee is a percentage of each transaction — they get to take full advantage of inflation without being exposed to price raise risk. If McDonald’s raises prices on their menu items, Visa’s profits go up. Oil prices go up? So does Visa’s bottom line. As the world’s economy grows, so does Visa. The awesome part is Visa doesn’t have to do anything!
The relatively low amount of money Visa has to spend on infrastructure and R&D means it has more money to spend on acquisitions and shareholder returns. It also is able to retire about 2.5% of its shares outstanding every year, meaning shares you buy now will represent a larger portion of the company as time goes on. Visa pays a small dividend as well (only a 0.8% yield as of now), though it has been aggressive in increasing the payment — it has doubled its dividend in the past 3 years.
Visa’s incredible past performance and resilient business model make me confident that it can continue its extraordinary performance going forward. It’s the reason Visa is on a very short list of companies I think is a good value buy anytime its P/E is 30 or below.