Nicholas Ward

I’m not going to lie; I’ve been somewhat concerned about the overall market’s valuation for a year or so now. I’ve taken steps to trim all of the low hanging fruit from my portfolio (lesser quality names, companies with slowing/negative growth, bond equivalent equities in a rising rate environment, and stock that I deem to be grossly overvalued). I’ve avoided trimming my highest quality names, regardless of valuation, because I believe that in the long-term investors are best off buying and holding industry leaders.

Tax reform in late 2017 lessened my concerns a bit. I suspect that we’ll see impressive y/y bottom line growth in 2018, though I still worry that the effects of this legislation will be short-term and serve as the boot that kicks the can down the road for another year. Because of this, I’m still cautious. I find myself constantly monitoring my portfolio (because I don’t like the idea of using stop loss/trailing stop orders), tracking valuations that rise well above historical norms. One of the names that I’ve been taking a close look at is Visa, a company that is up ~55% since the start of 2017, trading with one of the highest ttm P/E ratios since its IPO back in 2008.

I’ll start off with the bad when it comes to Visa: the aforementioned valuation.

As you can see in the F.A.S.T. Graph below, Visa’s recent share price run up is not matched by fundamental undertones. Visa is a wonderful company that has made a habit of producing top and bottom line growth that most companies in the world would be envious of; however, the market isn’t always rational and it appears that investors have put a premium on V shares that they simply don’t deserve.

Source: F.A.S.T. Graphs

Don’t get me wrong, I think Visa deserves a premium price. However, I’m not sure that Visa is in a better position today as a company than it was at any point since mid-2008. Visa did post top-line growth of 21.7% in 2017, which was its highest mark since going public in 2008; however, EPS growth only came in at 12.9%. It’s also worth noting that V’s top-line growth was only 9% in the recently reported Q1FY18, representing a potential slowdown back to the recent top-line growth norm (Visa’s sales grew 7.8%, 9.3%, and 8.7% in 2014, 2015, and 2016, respectively). Visa’s 2018 guidance currently calls for high single digit top-line growth as well, further calling the current premium valuation into question.

I say, “only” about this 12.9% figure because as great as it is, it is less than the company produced just a couple of years ago. There was awhile, from 2008 to 2013, that investors could count on 20%+ bottom line growth from Visa. The company is maturing and investors obviously can count on these types of figures moving forward over the medium to long-term. I don’t mind holding this company as it matures in the least; however, I do become concerned when the market appears to ignore this slowing growth with its valuation premium.

Frankly put, its rare that Visa’s top-line growth outpaces its bottom line figure in any given year; Visa management highlighted the fact that operating expenses are going to rise again in 2018 during their most recent ER conference call, though these cost will likely be canceled out, in the short-term, at least, by tax reform benefits. And while I love seeing revenue growth in the companies I own, I rarely evaluate them based upon the top-line (doing so is strictly speculative). Profits matter more than anything in the market which is why I’m surprised to see Visa’s premium increase in the face of decreasing earnings per share.

When it comes to being bearish on Visa, that’s about all I’ve got. Generally, I love holding my V shares. I sleep well at night doing so. I mentioned that I monitor them, which is true, but I haven’t sold for a reason. Market irrationality aside, Visa management is executing about as well as I could hope.

I already mentioned that sales increased 9% during Visa’s most recent quarter, but their other financial metrics were much more impressive. GAAP net income was up 22%. Adjusted net income was up 23%. GAAP earnings per share were up 25% while adjusted earnings increased 26%. Payment volumes were up 10%, cross border volume were up 9%, and processed transactions were up 12%. Needless to say, as strong as Visa’s market position appears to be in the credit card/processing space, they’re still growing.

Honestly, reading through Visa’s Q1 report it’s difficult for me to find disappointing figures. I could be nit-picky when looking at margins or growth in certain locales, but what’s the point? At the end of the day, Visa is a company operating in an essential duopoly (with MasterCard), with ~$14b cash on the balance sheet, and a generous management team that has made a habit of increasing shareholder dividends and reducing the outstanding share count via buybacks.

Speaking of buybacks, they slowed a bit in 2017 to ~1.7b; however, the company did use another $1.75b to retire long-term debt, which strengthens the balance sheet and is always a pleasant thing to see as a shareholder. For years Visa didn’t care any debt before adding it recently when it bought its European counterpart for ~$23b. Adding debt in such a low rate environment made sense to me, but I’ll never complain about management paying down debt.

While the buybacks slowed (just a tad), Visa has gone above and beyond with regard to dividend growth. Back in November of 2017, Visa increased their dividend right on schedule, giving investors an 18.1% raise, from $0.165/share to $0.195/share. 18.1% was great and helped to put my mind at ease regarding Visa’s valuation (this increase meant that from a dividend growth perspective, Visa was doing exactly what I expected it to).

Well, flash forward to February 1st, 2018 when Visa announced its next quarterly dividend and management raised the payment again. Back to back dividend increases is not an ordinary event and the 7.7% raise that investors can expect to receive when the first quarter’s dividend is paid in early March. This 7.7% increase on top of the previous 18.1% increase is music to my ears as a dividend growth investor. Sure, Visa’s yield is relatively low at 0.67% of a forward basis, but with 20%+ annual growth, it doesn’t take long for income oriented investors to see their yields on cost climb to very respectable levels.

To close this piece out, I’ll embarrass myself a bit. In mid 2015 I was in a position where raising cash made sense and I trimmed my Visa stake, locking in 37% gains, to do so. 37% gains were great…the problem is, I sold those shares for $69. Today, Visa trades for nearly twice that much. Granted, I’ve added to my Visa position several times since then, at $77.93 in late 2016 and $91.33, going overweight in Visa in early 2017, so I haven’t missed out totally on the recent run. But, I did learn a lesson back in 2015. I suppose I’m lucky that my lessons learned in the market involve 37% gains instead of 37% losses, after my mistake there’s been a simple truth engraved in my mind: don’t sell Visa.

So, you know what they say, fool my once, shame on you, fool me twice, shame on me. I appreciate Visa management reminding me not to be a fool with their last two dividend announcements. What about you? Are you thinking about taking profits after Visa’s massive run? Are you concerned about Visa’s share price being over valued too? Are you willing to ignore this (like me) because of the company’s strong operational and shareholder return performances? As always, I look forward to your opinions, comments, questions, and critiques. Until next time, best wishes all!

Disclosure: I am long V.