In the current economic environment, I am aiming to focus on traditional value principles such as robust economic moats, a competitive advantage that can stand the test of time, and of course, share prices that trade at a discount to my estimates of a company's long-term intrinsic value.
I do not think there is any sector or industry on the market that has a moat that is as deep as the major U.S. payment processing companies: Visa (V, Financial), Mastercard (MA, Financial) and American Express (AXP, Financial).
Every day, billions transactions use these companies' networks to process payments and, in the case of American Express, borrow money. This is not going to stop if the economy crashes. Transaction volumes might decline, and the total amount of spending through the network might also decline, but people still need to buy and sell essential items in an economic downturn. The economy will eventually recover, and these companies even have built-in inflation protection by taking a percentage of each transaction as revenue.
What’s more, the general global shift away from cash towards digital payments over the past few decades was further accelerated by the pandemic, which should offset some of the declines in transaction volumes.
But the question for investors is, is any one of these payments processing stocks offering better value than the others, or are they all the same? Let's take a look.
While these three companies are all extremely similar at their base, they also have major differences. I want to begin by pointing out that Visa and Mastercard are more similar to each other than to American Express.
American Express is more like a bank because, in addition to operating a payments network, it also lends money to consumers on its credit cards. This means it is more exposed to the economic downturn because if customers run into financial difficulties, they are unlikely to be unable to repay their outstanding liabilities in full. This means American Express has more exposure to potential defaults and customer losses.
And we can see how this has influenced the market's opinion of the business. It is currently trading at a forward price-earnings ratio of 12.5, compared to 21 for Visa and 24 for Mastercard.
Due to the difference in business models, Visa and Mastercard are about twice as profitable as American Express, although the return on equity across the group is relatively similar.
When it comes to balance sheet strength, both Visa and Mastercard have net cash balances compared to American Express’ complex balance sheet of assets and liabilities.
Looking at these three companies, Visa and Mastercard appear to have the better operating performance, although American Express is significantly cheaper.
The valuation cushion
As American Express operates more like a bank than a fintech company, it is a bit more complex to understand. However, the stock is cheaper, and there is more of a valuation cushion here.
At more than 20 times forward earnings, Visa and Mastercard still look expensive on some metrics, especially if we are heading into an economic downturn. If we see valuations suddenly plunge across the market, these companies are significantly more exposed than American Express.
But that does not mean they will underperform in the long term. History shows that expensive companies can remain expensive as long as they continue to earn higher returns on equity and post market-beating growth.
Another thing to note is the dividend yield on American Express shares. The stock currently supports a yield of 1.6%, compared to 0.9% for Visa and 0.7% for Mastercard.
So the question of which stock is the better value in the current environment really depends on one’s understanding of the financial sector and objectives. American Express is a more complex business, but the stock is cheaper. Visa and Mastercard are easier to understand. Still, they do command premium valuations. This may not hold up in an economic downturn, although over the next 20 years or so, this is unlikely to be an issue.