1. How to use GuruFocus - Tutorials
  2. What Is in the GuruFocus Premium Membership?
  3. A DIY Guide on How to Invest Using Guru Strategies
Dividend Monk
Dividend Monk
Articles (152)  | Author's Website |

3 Dividend Payers Benefitting from the Network Effect

March 14, 2012 | About:

This is the sixth and last in a series of articles highlighting dividend growth companies that have large and durable economic advantages, or “moats”, that protect their business operations and allow years or decades of strong profitability. When looking for long-term investments, one typically wants to find a business that is performing well not simply because management is on top of their game right now, but rather because the business itself has fundamental and difficult-to-replicate advantages over its competitors. The previous article described four businesses with natural monopolies.

This sixth and final description of a moat is the Network Effect. It comes last in the series, since it is most elusive among dividend growth companies, and tends to be far more common in technology and online companies.

When a business benefits from the network effect, it means that its products or services become more valuable as more people use them. This creates a huge barrier of entry for competitors, because it’s a virtuous cycle. As more people use a network, its products or services become inherently more valuable, and therefore even more people use the network, which leads to more value, and so forth. At that point, a competitor could copy the products and services, and even improve upon them, and yet without any sort of major catalyst, their products and services still won’t be as good.

Although powerful network effects can be difficult to find in the world of companies that pay dividends, here are three of them:

American Express (NYSE:AXP)

Among the most visible examples of the network effect in action among blue-chip companies is found in the card industry. As more consumers use charge cards, debit cards, and credit cards of a specific brand, the larger amount of pressure there is for merchants to accept payment from cards of that brand, and the more they accept those cards, the more desirable those cards are for consumers.

It’s important to note that there are two main kinds of card companies. There are the pure networks of Visa and Mastercard, and the credit companies of American Express and Discover. Visa and Mastercard do not directly hold any consumer debt. Banks issue those cards instead, and Visa and Mastercard provide the global payment processing network. Visa has the largest network, and therefore arguably the largest network effect. Then there are the credit card companies of American Express and Discover that issue cards and hold consumer debt, and are therefore fundamentally different than the other two.

Of all of these network and credit companies, American Express is the largest in terms of revenue. They target affluent individuals, small businesses, and corporations. They differentiate themselves with higher fees and more services. Due to the regulatory risks and slower growth of being in a different industry, as well as the strong hold that Visa and Mastercard have on bank-issued cards, American Express stock does indeed deserve a lower valuation. However, I believe American Express stock should be a decent choice going forward, based on the current valuation.

There aren’t particularly appealing dividend yields in this industry. It’s unfortunate that the best example of a network effect in the blue-chip world, has a host of low dividend yields and lack of consistent dividend growth history. Even American Express, with the largest yield of the bunch, only has a 1.33% dividend yield. The valuations of these stocks vary considerably. There are high valuations for Visa (trading for around 30 times earnings) and Mastercard (trading for around 28 times earnings), since they have great growth prospects. At the same time, there are lower valuations for American Express (trading for 13 times earnings) and Discover Financial Services (trading for 8 times earnings). All of them have low dividend payout ratios, including American Express which pays out less than 20% of earnings as dividends, and unfortunately hasn’t grown the dividend since 2008.

McGraw-Hill (MHP)

McGraw-Hill is the parent company of Standard and Poor’s (S&P) and J.D. Power and Associates, and is a major publisher.

Rating agencies like S&P currently have high barriers of entry due to the network effect. There is therefore an oligopoly. The more common and ubiquitous their ratings are, the more necessary it is for a business to be rated by them. Their ratings quality has been called into question for numerous reasons, including failing to adequately judge risk before the financial collapse. There is consistent litigation risk.

McGraw Hill stock fortunately has a slightly larger yield and more consistent dividend growth than American Express. The company has grown its dividend consecutively every year since the 1970′s, and currently offers a 2.16% dividend yield. The most recent dividend increase, however, was only 2%. I don’t find MHP stock to be an appealing value at the current price.

Microsoft (NASDAQ:MSFT)

As previously mentioned, there is no shortage of network effects in the tech and online world.

Ebay, for instance, has its services strengthened in proportion to the number of users. The more users that exist on Ebay, the more it makes sense to use that service for auction needs. Ebay’s Paypal is in a similar network effect position to the card companies. The larger the market share of online payments that Paypal can capture, the more consumers and merchants will use Paypal, and therefore more consumers will follow.

Other examples are the Social Media sites. Facebook, Twitter, and Google+ are the big three to mention, but any niche social media site qualifies as well.

Google, Amazon, and Apple battle for dominant networks. It’s more about platforms than about products at this point. They strive to get their devices in the hands of more people, which makes their application ecosystem more attractive for developers. As a higher quantity and quality of apps are developed, the platform itself is strengthened in a virtuous cycle of media/content delivery and consumption. These are some of the strongest network effects around. Amazon focuses on the physical realm as well, and the larger its platform is, the bigger the network effect becomes.

Microsoft is coming towards a similar position. While they’ve missed out on much of the mobile market share, Microsoft has always used the network effect to its advantage. Their Windows and Office products became so commonplace, that training and certification programs were introduced. Being able to use their products, therefore, became a standardized and marketable skill. And the more people that had these skills, the stronger and more ubiquitous the products became.

Microsoft has lost some of that dominance, but with the upcoming Windows 8 and Windows Store, they’ll have an app platform across personal computers and potentially into tablets. Microsoft has historically understood the importance of developers in their business. The larger number of consumers that use Microsoft platforms, the more incentive there is for developers to create better and more numerous apps, and the more attractive the platform of apps/media/content is, the more competitive it can be with regards to attracting or retaining consumers.

There will likely continue to be a healthy mix of strong application/media/content platforms, and in particular, I expect Google Play to strengthen Google’s position. Microsoft stock is the only one of the group that offers a dividend, and currently has a yield of 2.45%. The most recent dividend increased was 25%. I’ll be talking about Microsoft more in an upcoming analysis article, and in my next dividend newsletter edition.


In conclusion, economic advantages, or “moats” are critical to establishing a long-term business. These can range from economies of scale, to global brands, to patent shields, to high switching costs, to natural infrastructure monopolies, to network effects. Dividend growers tend to have one or more of the first five types of moats, while moats in the tech world are very strongly based on the platform; the network effect.

Full Disclosure: I am long MSFT at the time of this writing.

About the author:

Dividend Monk
Dividend Monk provides free stock analysis articles with an emphasis on dividend-growth investments. Also discussed are investing strategies, personal finance, and industry outlooks.

Visit Dividend Monk's Website

Rating: 3.5/5 (19 votes)


Please leave your comment:

Performances of the stocks mentioned by Dividend Monk

User Generated Screeners

pascal.van.garsseHigh FCF-M2
kosalmmuseBest one1
DBrizanall 2019Feb26
kosalmmuseBest one
DBrizanall 2019Feb25
MsDale*52-Week Low
Get WordPress Plugins for easy affiliate links on Stock Tickers and Guru Names | Earn affiliate commissions by embedding GuruFocus Charts
GuruFocus Affiliate Program: Earn up to $400 per referral. ( Learn More)

GF Chat