Mastercard is one of the best stocks you could have in your portfolio. As you know, it rules the credit card world along with Visa. The fees come with every single transaction, and the costs are generally fixed and the business model is asset light so 43.5% net profit margins are maintained. As a result, profits have sextupled over the past decade. Even if your expectations for business performance are unreasonably high, Mastercard still finds a way to exceed them.
But Mastercard is now a $200+ billion entity trading at 33x earnings. Since its IPO in 2006, this is by far the highest valuation, excluding the wildly fluctuating price immediately after the IPO. In four out of the past ten years, the stock maintained a P/E ratio below 20.
My expectation is that Mastercard shareholders will experience something analogous to what Microsoft investors endured from 2003 through 2012–a period of extended earnings per share growth with stock performance that does not quite match. Why? Because the valuation needs something close to a 40% haircut.
Even with 14% earnings per share growth, which is quite favorable assumption, Mastercard would be earning around $11 per share five years from now. The current price is $208. If the P/E ratio compresses to 18.9x earnings, you’d be looking at prices that match October 8, 2018.
It is not inconceivable that Mastercard stock grows its profits at a double-digit rate while delivering shareholder returns that barely eke past inflation.
Teaching yourself to become immune to recency bias is a worthwhile skill. The only people who think that the historical valuation metric of 20x earnings no longer applies to megacaps are those who have seen prices in the past year or two mimic the late 1990s excess and figure “what just happened” is the same thing as “what will happen.”
I do suggest alternatives. We live in a world where Mastercard will grow moderately faster than Synchrony and it is a better business, but yet, Synchrony shareholders will earn far superior returns to Mastercard shareholders during this October 8, 2018 through October 8, 2023 stretch.
Right now, growth is roaring indiscriminately in relation to price. Soon enough, valuation will get its turn.