Visa Continues To Dominate, Announces 4 For 1 Stock Split

If you’re familiar with the writings of Peter Lynch, one of his observations that you will encounter is the notion that when companies report great earnings, the price of the stock will tend to overshoot and make the company a little bit more expensive than what it should fairly be. This happens on the way down, too—when a company reports disappointing results, the price of the stock tends to get cheaper than deserved (and becomes the interest of value investors). In reaction to this typical phenomenon, Wall Street analysts have the annoying tendency to downgrade and recommend selling stocks that deliver earnings growth that is better than anticipated.

Peter Lynch derisively called this practice “cutting the flowers and watering the weeds”, and obviously, I am not a fan of it because it treats the investor community as nothing more than a collection of traders rather than people interested in owning businesses for long periods of time, ideally decades. To put it in more logical terms, I don’t want to just own a business when it is working through some problems (often times, to get a good entry price on a stock, you have to do something unpopular like buy BP dealing with the oil spill, McDonald’s dealing with changing customer preferences, IBM dealing with trouble growing revenue, GlaxoSmithKline dealing with the bribery scandal, Philip Morris International dealing with trouble in Russia and a strong U.S. dollar, etc). But from there, the big dividend growth and rapidly rising stock price will come during the years when the business is performing exceptionally well.

Right now, Visa is in an extended mega-cycle of growth as electronic purchases becoming increasingly common and prevalent while it has deep pockets in the form of brand protection and has ubiquity among retailers (i.e. it’s hard to operate a store that doesn’t take a Visa card, not so difficult to run a store that wouldn’t take a Logos credit card brand that you hatch up with some venture funding).

Today, Visa continued its record of reporting exceptional quarterly results to investors: the amount of money being transacted with Visa cards is up 11% compared to this time last year, the number of actual transactions is up 10%, and profits per share for the quarter came in at $2.53. Last year, the figure was $2.20. Over the course of 2015, Visa is expected to make $10.50 compared to $9.07 last year. The dividend payout ratio is still well under 20%, suggesting future room for long-term dividend growth at a rate above the actual profit growth of the company (this will probably continue until Visa pays out around half of its profits in the form of dividends).

Is the valuation high? Yes, the company now trades in that 26, 27, 28x earnings range. This is probably a bit above where the shares will permanently rest in 20-23x earnings range a few years from now. But where I disagree with the Wall Street advise is that I do not believe this constitutes a reason to sell the stock for those of you that hold it. It is unlikely that any stock in your portfolio is consistently growing profits, dividends, and yes, share price at a rate quite like Visa. With each year of profit growth, the true fair value of the stock likewise increases.

Visa has a fair shot of earning $14, $15, $16 per share in profit five years from now. Even if the P/E ratio comes down to, say, 21x earnings, this is still a stock that could be trading in the $330s a few years from now. Of course, Visa wouldn’t actually see that price—that brings us to today’s next item of news, the 4 for 1 stock split, so Visa’s stock price will come down to the $60s sometime in the next couple of months and your share count will be multiplied by a factor of 4 (e.g. if you own 50 shares of Visa now at $260, you will see your account hold 200 shares of Visa trade at $65 per share after the split).

The reason why Visa is doing this is entirely cosmetic; it’s not as if there are serious impediments preventing someone from buying Visa stock at $260 per share (if you wanted to buy some, you’d only need to come up with $270 to come up with the cost of 1 share plus a commission, though I don’t recommend making purchases where you spend more than 1% in transaction costs). Basically, if you buy a brokerage fee to something like Schwab, I would advise saving up to make purchases in increments of $1,000 or more. If this is a hardship, I would visit Loyal3 or Computershare and find a suitable company to purchase that does not charge any transaction fees.

But one consequence of these cosmetic changes through stock splits is that it makes it easier for stocks to maintain lofty valuation multiples—when Visa trades in the $60s, it is easier to get away with a valuation in the 25-30x range than when the price flies deeper into the hundreds (this is because of the behavioral tendency, no matter how irrational, to associate lower stock prices with cheapness even though it is the underlying earnings that actually matter).

But still, you don’t sell an excellent business when it gets a little bit pricey. Someone who owned Visa in 2011 saw profits at $4.99. They grew to $6.20 in 2012. Then $7.59 in 2013. Then $9.07 in 2014. And the figure continues to grow at an impressive clip. Arguing whether the price should be $230, $240, $250, or $260, in this case, leads to overlook the forest because you’re too caught up with the specific trees because you own a business that is rapidly growing. Unless you are dealing with a valuation that is north, of say, 40x earnings, you could do a lot worse than to adopt the policy of never selling a stock that is growing profits at a rate of 10% annually or more.